Home Equity Loan vs. Mortgage: The Main Differences & Similarities
7 Min Read
Do you own a house and want to use it as collateral to get some extra cash? Or do you want to buy a brand-new home to live in? Grab a pen and notebook because we’re about to embark on a wild ride exploring the differences and similarities: home equity loan vs. mortgage.
Also, if you ask yourself sometimes, “Is a home equity loan a mortgage?” financial experts of 1F Cash Advance decided to make it clear. We will cover the main aspects to help you choose between these two financial options.
- What is a Mortgage?
- How Does Mortage Work?
- What is a Home Equity Loan?
- How Does Home Equity Loan Work?
- Difference Between Home Equity Loan and Mortgage
- Similarities Between Mortgages and Home Equity Loans
- Is a Home Equity Loan a Second Mortgage?
- Are Home Equity Loan Rates Lower than Mortgage Rates?
- Can You Have a Home Equity Loan Without a Mortgage?
- Check Home Equity Loan Alternatives & Cover Your Home Expenses
What is a Mortgage?
If you’re thinking of buying a house but don’t have enough money in your bank account, try applying for a traditional mortgage loan you can get from a bank. It’s your primary mortgage before you think about getting a home equity loan if you need to. A mortgage has a long-term repayment schedule of 15 or 30 years.
With this type of loan, you could borrow up to 80% of what your future home is worth. For example, if it is worth $250,000, the loan provider can lend you up to $200,000; you’ll need to cover the rest.
How Does It Work?
Mortgage lenders verify your financial standing to identify the interest rates. Plus, they perform a hard credit check through major credit reporting bureaus. It means a lender requests your credit report and checks your monthly payment history, credit score, and other financial information. Remember, these checks may affect your FICO score in the long term.
Mortgage loans can come with a fixed or variable interest rate that might fluctuate depending on the market. But if you want to play it safe and avoid the uncertainty of market ups and downs, go for a fixed interest rate.
Now, here’s the thing. If you can’t repay the current mortgage on time, the lender has the right to resell the collateral (which is your house) to recover the expenses. So, be smarter when it comes to borrowing mortgages. Financial experts of 1F Cash Advance suggest you evaluate your financial situation and search for improvements, like cutting expenses, or finding a part-time job.
What is a Home Equity Loan?
If you’ve built up some serious home equity, you can borrow money against it! They call it a home equity loan. Your home is collateral and helps you get a suitable loan amount. With this money, you can get rid of debt or even borrow to pay for student expenses.
A home equity loan typically has a fixed interest rate, making them predictable and easier to manage. But these costs are higher compared to the first mortgage.
How Does It Work?
Before you apply for a home equity loan, it’s crucial to understand how it works and what you can do to avoid further issues. Your home’s equity is the difference between its value on the market and how much you still owe on your first mortgage. As you make those monthly mortgage payments, you’re slowly but surely building up your home’s equity.
You can get a home equity loan from traditional financial institutions like banks or credit unions. They usually start with assessing your creditworthiness, employment history, and the equity you have in your home. There are also home equity loan options for bad credit borrowers as well. But they typically come with higher interest rates.
Once the lender approves your loan request, you’ll receive a lump sum payment. Typically it takes up to several business days to fund the money. The cut-off times may vary by lender and workload.
These financial products are installment loans because you’ll have to make fixed monthly payments over the loan term, including principal and fixed interest rates. It is important to note that home equity loans create a lien on the property, meaning the lender has a legal claim to the home until the loan is fully repaid. The lender can initiate foreclosure proceedings to recover the remaining balance in the event of non-payment.
Difference Between Home Equity Loan and Mortgage
You don’t understand the differences if you don’t know what to choose: a mortgage or a home equity loan, as they are used in the same context. Here are the points that differentiate these loans:
- Specific purpose: If you want to buy a house, check out a mortgage loan. If you need money to cover significant expenses, try a home equity loan.
- Interest rates: The primary mortgages have lower interest rates than home equity loans because the lender’s risk is higher.
- Repayment terms: The repayment period of mortgages ranges from 10 to 30 years; meanwhile, an equity loan starts with a 5-year term and reaches 30.
- Application process: The requesting processes for a home loan and equity loan differ. When applying for a mortgage, lenders check your creditworthiness, employment history, income stability, and other factors to see if you can cover the debt on time. When requesting an equity loan, the amount of equity available in the property is the leading factor lenders consider.
Similarities Between Mortgages and Home Equity Loans
While differences between a home equity loan and a mortgage were covered, let’s explore several similarities between these two loan products:
Both mortgages and home equity loans involve using a property as collateral. In both cases, the lender claims the property if the borrower fails to repay the loan.
Perfect for Major Expenses
Both loan products can be used to finance major expenses. Mortgages are primarily used to finance the purchase of a home. In contrast, the second type of loan helps you cover any expenses.
Both financial tools may offer tax benefits to borrowers. Their interest rates are tax-deductible if the loan amount doesn’t exceed the amount of $750.000.
Is a Home Equity Loan a Second Mortgage?
Sometimes, a home equity loan is considered a second mortgage, but not in all circumstances. The equity of your house is built by you making the monthly payments on your primary mortgage. So, if you default on your debt, the primary mortgage lender will take your house. But if you own your house in full, the home equity loan cannot be considered a second mortgage.
Are Home Equity Loan Rates Lower than Mortgage Rates?
Traditionally, home equity loans tend to have higher interest costs compared to mortgage loans. It is primarily because the property itself secures the initial mortgage. So these second mortgage loans are considered riskier for a lender.
Meanwhile, home equity loans allow you to borrow against the equity you have built up in your property. Since these loans are secondary to the primary mortgage and rely on the property equity as collateral, lenders may perceive them as slightly riskier. That’s why lenders put higher interest charges compared to mortgage loans.
Can You Have a Home Equity Loan Without a Mortgage?
Yes, it is possible to have a home equity loan without a mortgage loan if you bought your home outright or received it through inheritance.
Some lenders can still have specific eligibility criteria for the minimum credit score. By not having a mortgage and borrowing a home equity loan, you’ll increase the amount you’ll borrow from the latter loan product.
Check Home Equity Loan Alternatives & Cover Your Home Expenses
When homeowners need help with their finances to fund projects, they often consider using the equity in their homes to borrow suitable amounts with an affordable monthly payment. While home equity loans are a popular choice, we suggest exploring unconventional options that might better suit borrowers’ money issues. Here is what 1F Cash Advance recommends:
You can choose a cash-out refinance method to refinance your old mortgage and to get more money than you currently owe on that mortgage. It works easily! The lender gives you one lump sum you can spend on whatever you want. When you go for a cash-out refinance, you must be ready to pay related to the closing costs, around 2% – 5% of the loan value.
Remember that you could have higher interest rates in the long run. So, financial experts recommend you be smart about it and assess your financial possibilities first.
Home equity lines of credit (HELOC)
Many consumers surf the Internet and type “Is a HELOC a mortgage loan?” hoping to find the truth, but here’s the catch about this loan product. A home equity line of credit functions similarly to a credit card, allowing homeowners to borrow against the equity in their homes as needed, up to a predetermined credit limit and draw period.
This type of loan can be particularly beneficial for those anticipating ongoing expenses, such as funding a child’s education or managing home renovations. Additionally, interest is only incurred on the amount borrowed from the credit line rather than the total credit limit of the draw period. However, it’s crucial to exercise caution with HELOCs, as they often come with variable interest rates and the potential for increased debt if not managed responsibly.
We’ve explored the distinctions and similarities between home equity loans and mortgages. So now you know that a traditional mortgage is obtained from a bank and allows you to purchase a home by borrowing up to 80% of the home’s value. Mortgages have long repayment schedules of 15 or 30 years and can have fixed or variable interest rates.
On the other hand, a home equity loan allows homeowners to borrow money against the equity they have built in their homes. The equity is the difference between the home’s market value and the remaining mortgage balance. They typically have fixed interest rates, making them predictable. They can be used for various purposes, such as debt consolidation or covering significant expenses.
Despite these differences, mortgages and home equity loans share some similarities. Both loans use the property as collateral, meaning the lender can claim the property if the borrower fails to repay the loan. Additionally, both loans can finance significant expenses, and their interest may be tax-deductible under certain conditions.