Is a Home Equity Loan the Same as a Mortgage?

A home equity loan and a mortgage may sound similar, but they are quite different financing options for homeowners. Understanding how they differ is important when deciding which type of loan is right for your needs.

What is a Mortgage?

A mortgage is a loan used to purchase or refinance real estate, like a house The property serves as collateral on the loan This means if you stop making payments, the lender can foreclose and take possession of the home.

With a mortgage, you make regular monthly payments consisting of principal and interest over a set loan term. This is usually 15 or 30 years As you make payments, you build equity in the property

Mortgages come in a few main types:

• Conventional – Offered by private lenders and not part of a government program. Typically require a down payment of at least 20%.

• FHA – Insured by the Federal Housing Administration. Only require a 3.5% down payment. Popular with first-time home buyers.

• VA – Offered by private lenders but partially guaranteed by the Department of Veterans Affairs. No down payment required for eligible veterans and service members.

• USDA – From the US. Department of Agriculture for properties in rural and suburban areas 100% financing available.

• Jumbo – For loan amounts above conforming loan limits. Typically have higher rates and stricter requirements.

In most cases, your mortgage is the first lien on the property. This gives it priority in recouping money if the home is foreclosed on and sold.

What is a Home Equity Loan?

A home equity loan is different from a mortgage in several key ways:

Purpose – With a home equity loan, you’re borrowing against the equity in your home, not purchasing the home itself. Equity is the current market value of your home minus what you owe on your mortgage.

Collateral – Your home still serves as collateral, meaning the lender can foreclose if you default. But a home equity loan is a second lien on the property, behind your primary mortgage.

Loan amount – Home equity loans are for smaller amounts, up to 85% of your home’s value. But you can only borrow against your available equity after subtracting your current mortgage balance.

Payments – Because it’s a second lien, you’ll make monthly payments on the home equity loan in addition to your existing mortgage payment.

Interest rates – Home equity loans typically have slightly higher interest rates than mortgages since they are riskier for lenders.

Loan term – Home equity loans often have shorter terms of 5-20 years versus 15-30 years for mortgages.

Tax benefits – You may be able to deduct interest on home equity loans on your taxes if you itemize deductions.

Comparing Mortgages and Home Equity Loans

As you can see, mortgages and home equity loans share some common features but have very distinct uses.

When to Use a Mortgage

Here are some of the main reasons you might take out a mortgage loan:

• Buying a home
• Refinancing your current mortgage for a lower rate or different loan terms
• Buying a second home or investment property
• Receiving a VA mortgage with no down payment as an eligible veteran
• Getting a USDA home loan for a low-cost rural property
• Purchasing a high-value home with a jumbo loan

Unless you can pay cash, getting a mortgage is typically the only way to buy a home. Even if you have equity, you can’t use a home equity loan for this purpose.

When to Use a Home Equity Loan

Some common uses for home equity loan funds include:

• Home improvements and renovations
• Consolidating high-interest credit card debt
• Paying college tuition
• Covering medical expenses
• Starting a business
• Purchasing another property

A home equity loan converts equity you’ve built up into cash. It lets you access funds without selling the home or changing your primary mortgage.

Home equity loans offer fixed rates and predictable payments. This can make it easier to budget for the loan than borrowing through other means like credit cards or personal loans.

Key Differences Summarized

While mortgages and home equity loans are both secured lending products, they serve very different purposes for homeowners. Here are some of their key differences:

• Mortgages are for financing real estate purchases while home equity loans let you borrow against existing equity.
• Mortgages have lower interest rates as first liens while home equity loans have slightly higher rates as second liens.
• Mortgages have longer repayment terms of 15-30 years versus shorter 5-20 year terms for most home equity loans.
• Mortgages fund the entire purchase price of a home but home equity loans are for smaller amounts based on your available equity.
• Home equity loans have an additional monthly payment separate from your primary mortgage payment.

Which Loan Type Is Right for You?

Determining if you should get a mortgage or home equity loan depends on your specific situation and financial goals.

If you want to buy a home or investment property, a mortgage is likely your best option. Refinancing into a new mortgage can also help you secure a better rate or terms.

But if you’ve built up equity and need funds for other expenses, a home equity loan allows you to borrow against that equity without changing your primary mortgage. This route may make sense if you already have a low mortgage rate and manageable payments.

Be sure to shop around and compare rates and fees before deciding. A mortgage lender can help you fully understand the costs and benefits of both loans. Doing your homework can ensure you get the optimal financing solution.

The Bottom Line

While a home equity loan and mortgage are both secured by your property, they are very different lending tools. Now that you know the key distinctions, you can determine which type of loan better matches your home financing needs. With this knowledge in hand, you can confidently choose the right option and start putting the funds to work.