Home Equity Loan vs. Mortgage – When it comes to buying a house or financing major expenses or purchases, the two most prominent options are mortgages and home equity loans. Although both options allow borrowers to use collateral or property as collateral to secure a loan, they have specific features and unique purposes.
This raises the question: home equity loan vs. mortgage: what’s the difference? Before we begin, it is important to understand the intricacies between a traditional mortgage and a home equity loan to make the right decision for your financial goals and needs.
What is a Home Equity Loan?
A home equity loan is a type of loan that enables homeowners to borrow against their property’s equity. For those who are unaware, equity is the difference between the current value of your home and the outstanding balance on your mortgage.
More importantly, it is an effective way to get funds based on the value of your home. In addition to this, a home equity loan can be used for expenses like debt consolidation, home improvements, and major life events.
How Does Home Equity Loan Work?
Similar to a second mortgage, that is how a home equity loan works or functions. In other words, you can take out a lump sum of money which you will have to pay back in a particular monthly payment term. Hence, your home is securing the loan as collateral therefore; if you do not pay back, your property is at risk. The borrowed amount is usually based on the equity you have in your home or property.
Pros and Cons
Here are the pros and cons of considering a home equity loan:
Pros
- Lump sum payment.
- Fixed interest rates.
- Increased home value.
- Longer repayment terms.
- Debt consolidation.
- Potential tax benefits.
- Lower interest rates.
- Foreseen payments.
Cons
- Reduced equity.
- Foreclosure risk.
- Market fluctuations.
- Extended commitment and debt obligations.
- Closing costs.
- Negative impact on credit.
- Interest rate risk.
- Limited equity.
What is a Mortgage?
A mortgage is a type of loan that is used specifically to buy real estate, where the property is used as collateral. The loan is typically paid back over a long period in monthly installments like 15 or 30 years. In addition, mortgages exist in different types such as adjustable-rate and fixed-rate mortgages and they both have different conditions and terms.
How Does a Mortgage Work?
Generally, a mortgage involves taking out a particular amount of money or funds to purchase a home. However, this loan needs to be secured by the property. In other words, your home or property will be used as collateral by the lender. Meanwhile, the borrower will need to make regular monthly payments that embody both the principal and interest. As time goes on, you will pay the loan back gradually while the property is still serving as collateral. The repayment period and interest rates differ based on your financial circumstances and the lender.
Pros and Cons
Here are the pros and cons of a mortgage:
Pros
- Fixed payments.
- Long-term investment.
- Homeownership.
- Lower interest rates.
- Personalized terms.
- Tax benefits.
- Possible property value appreciation.
- Equity build-up.
Cons
- High-interest costs.
- Property taxes and insurance.
- Long-term financial commitments.
- Negative credit impact.
- Foreclosure risk.
- Market risk.
- Continuous maintenance costs.
- Substantial down payment.
Home Equity Loan vs. Mortgage: What’s the Difference?
Here is a table comparing a home equity loan and a mortgage to show their differences in various aspects:
| Feature | Home Equity Loan | Mortgage |
| Description | This is a loan type based on the equity in your home | This is a loan used to buy real estate |
| Loan Type | Line of credit or second mortgage | Primary loan or first mortgage |
| Collateral | Your home | Your home |
| Purpose | For major expenses | For buying a home |
| Fund Use | For various purposes | Specifically for purchasing a home |
| Equity Requirement | Enough is required | Not applicable |
| Foreclosure Risk | Yes | Yes |
| Repayment Term | Usually 5-15 years | Usually15-30 years |
| Impact on Debt-to-Income Ratio | Yes | Yes |
| Flexibility | Less | More |
| Equity Impact | Reduces | Builds |
| Tax Benefits | Subject to tax laws | Subject to tax laws |
| Down Payment | Not required | Required |
| Repayment Structure | Fixed or variable | Fixed or variable |
| Closing Fees and Costs | May includes | Usually includes |
| Loan Amount | Based on your home equity | Based on your property’s purchase price |
| Application Process | Simpler | Complicated |
Which Loan Type is Best for Me?
Selecting the suitable choice for you between a home equity loan and a mortgage largely depends on your financial needs and goals. A mortgage might be a perfect option for you if you need long-term financing or are looking to buy a home.
However, if you already own or have a house and need access to funds for improvements or large expenses, you might want to consider a home equity loan.
Hence, it is important to consider the purpose of the loan, possible benefits and risks, and your current financial situation before deciding. Additionally, you can reach out to a mortgage specialist or a financial advisor who can help you customize your preferences.