A mortgage and a home equity loan are both types of loans that allow homeowners to borrow money using their homes as collateral. However, there are some key differences between the two that you should be aware of before making a decision on which type of loan is right for you. In this guide, we will explore the different features and characteristics of mortgage and home equity loans, and help you understand which option may be the best fit for your financial needs and goals.
Mortgage
A mortgage is a loan that is used to purchase a home. The lender provides the borrower with the funds needed to buy the property, and the borrower agrees to pay back the loan, with interest, over a period of time. The length of the loan term can vary, but most mortgages have a term of 15 or 30 years.
To qualify for a mortgage, the borrower must have a good credit score and a stable income. The lender will also consider the borrower’s debt-to-income ratio, which is a measure of how much of the borrower’s income is used to make debt payments. The lender will also assess the value of the property being purchased and determine how much they are willing to lend based on this value.
Once the loan is approved, the borrower will make monthly payments to the lender, which will include both the principal (the amount borrowed) and the interest (the cost of borrowing the money). As the borrower makes payments, the amount of the loan that has been paid off (the principal) will decrease, while the amount of interest paid will decrease over time.
Home equity loan
A home equity loan is a type of second mortgage that allows a homeowner to borrow money using the equity in their home as collateral. Equity is the difference between the value of the home and the amount of any outstanding mortgages or liens on the property.
To qualify for a home equity loan, the borrower must have built up enough equity in their home, and must also have a good credit score and a stable income. The lender will assess the value of the home and determine how much they are willing to lend based on this value and the amount of equity the borrower has in the property. In general, you will need a maximum 85% loan-to-value (LTV) ratio to meet home equity loan requirements. Your LTV ratio is the percentage of your home value that is financed by a mortgage. Additionally, you may be limited to borrowing 85% of your home’s value, minus your outstanding loan balance, though some lenders offer high-LTV home equity loans.
The terms of a home equity loan are typically shorter than those of a mortgage, with most home equity loans having a term of 5 to 15 years but can be as long as 30 years. The borrower will make monthly payments to the lender, which will include both the principal and the interest.
Difference between a home equity loan and a mortgage:
There are several key differences between mortgages and home equity loans that you should consider before deciding which option is right for you. Here are a few of the main differences:
- Purpose: Mortgages are typically used to purchase a home, while home equity loans are used to borrow a large sum of money using the equity in your home as collateral.
- Interest rate: Interest rates on a mortgage are typically lower than the interest rate on a home equity loan. This is because the lender assumes less risk with a mortgage, as the mortgage lender has first priority on repayment in the event of a default.
- Loan terms: The terms of a mortgage are typically longer than those of a home equity loan, with most mortgages having a term of 15 or 30 years. In contrast, home equity loans usually have a term of 5 to 15 years.
- Maximum loan amount: The maximum loan amount for a mortgage is typically higher than the maximum loan amount for a home equity loan. This is because the lender is using the value of the entire property as collateral for the mortgage, whereas the home equity loan is secured only by the equity in the property.
- Closing costs: The closing costs for a mortgage are typically higher than those for a home equity loan.
- Tax deductible limits: Interest paid on a home equity loan may be tax deductible if build or substantially improve the homeowner’s dwelling, compared to a mortgage where you can deduct the interest on up to $750,000.
Second mortgage:
A second mortgage is a loan that is taken out using a property that is already being used as collateral for a first mortgage. The second mortgage is a secondary loan that is taken out in addition to the first mortgage, and it is typically used to borrow a large sum of money.
Second mortgages are typically used to fund home renovations, pay off high-interest debt, or finance large purchases. Like a home equity loan, a second mortgage allows a homeowner to borrow money using the equity in their home as collateral.
However, because the second mortgage is a separate loan from the first mortgage, the borrower will have to make separate monthly payments to the two lenders. The interest rate on a second mortgage is typically higher than the interest rate on a first mortgage.
Cash-out refinancing:
Cash-out refinancing is a way to take out a new mortgage that is larger than the balance of the borrower’s existing mortgage, and use the excess funds to pay off other debts or make a large purchase. When a borrower does a cash-out refinance, they are essentially replacing their old mortgage with a new one and taking out the difference in cash.
For example, if a borrower has a mortgage balance of $200,000 and they take out a new mortgage for $250,000, they will receive $50,000 in cash at closing. This cash can be used to pay off credit card debt, fund home renovations, or make a large purchase.
Can you have a mortgage and a home equity loan:
Yes, it is possible for a homeowner to have both a mortgage and a home equity loan. In this case, the homeowner would be making payments on two separate loans, one for the mortgage and one for the home equity loan.
Having both a mortgage and a home equity loan can be a good option for homeowners who need to borrow a large sum of money and have built up a significant amount of equity in their homes.
Which is the best option for you:
The best option for you will depend on your financial situation and your borrowing needs. Both mortgages and home equity loans can be useful tools for borrowing money using your home as collateral. However, there are some key differences between the two that you should be aware of before making a decision. Consider your financial situation, borrowing needs, and long-term financial goals when deciding which option is best for you.
