Home Equity Loan Vs. Mortgage: What Are the Differences?

Mortgages

Home Equity Loans or Mortgages?

When borrowing money from a bank or another financial institution, people often need to provide a lender with collateral. Both in mortgages and home equity loans, your home serves as the guarantee for a lender you will return the money. Otherwise, a loan provider can seize your property.

While they have many similarities, the two borrowing options function differently. A home equity loan vs. mortgage? Keep reading to explore all the differences between these secured loans.

How Does a Mortgage Work?

Mortgages are secured loans borrowed to purchase a property where the home you buy serves as collateral. As a result, a lender can seize your house if you fail to repay the funds. After obtaining the funds, people return the debt for 30 years through fixed or variable monthly payments. However, in several cases, borrowers apply for 15-year mortgages.

When applying for a mortgage loan, you must meet the following lender’s eligibility requirements:

  • A minimum credit score;
  • A debt-to-income ratio (DTI);
  • A minimum down payment;
  • Sufficient income.

How Does a Home Equity Loan Work?

Home equity loans are loans secured by your property, which means you must own a home to apply for this financing option. Similar to a mortgage, a home equity loan has an installment structure and is repaid through monthly payments. However, unlike traditional mortgages, home equity loans always have fixed interest rates.

Furthermore, a home equity loan can be used for various purposes, such as paying medical bills, debt consolidation, home improvement, etc.

A home equity loan is often called a second mortgage, as it allows you to use your property to borrow more cash.

Similarities: Home Equity Loans and Mortgages

A home equity loan works similarly to a mortgage. Here, you can see all the common elements of these two borrowing options:

  • Loans secured by property;
  • Lower interest rates than in other loans;
  • Have similar eligibility criteria;
  • Allow borrowing a large amount.

Differences: Home Equity Loans and Mortgages

While they have many common features, the two secured loans do not work the same way and are used for various purposes. It is essential to take into account the main difference between home equity loan and mortgage to understand them better and choose a more suitable option for your purposes.

  • Home equity loans can be used for various purposes, while with mortgages, you can only buy property;
  • Mortgages have lower interest rates;
  • An interest rate for a mortgage can be fixed or variable, while for a home equity loan, it is always fixed;
  • A mortgage is in the first lien position, whereas a home equity loan is in a second or subsequent position.

Bottom Line

When considering what is better between a home equity loan vs. a mortgage, it is essential to consider several factors. Although both are secured by property, cheaper than other types of loans, and have similar requirements, these loans differ in their purposes, interest rates, and other aspects.