Key Differences Between a Home Equity Loan and a Mortgage

Home equity loans and mortgages allow borrowers to use their houses as collateral. There are some differences between them. To be eligible for a home equity loan, a borrower must first own a house and have enough equity. Traditional mortgages, also known to be purchase mortgages, are used to purchase a property. The proceeds of traditional mortgages can’t be used to buy a house. However, home equity loans can be used for any purpose.

What is a mortgage?

A purchase mortgage is used to buy a house. It typically has a fixed rate and monthly payments that last 30 years. There may be adjustable interest rates or terms longer than 10 years.

Homebuyers must pay a down payment between 3% and 20% to obtain a mortgage. The majority of buyers deposit 6%. Some government-backed loans like VA loans do not require a down payment.

The monthly payment for a purchase loan mortgage includes multiple types of payments. A portion of the monthly payment is used to pay interest. A portion is used to pay the principal balance. A portion is usually applied to the principal balance. The mortgage servicing company uses the escrow fund to pay property taxes and hazard coverage. Private mortgage insurance premiums may be required for certain loans.

The principal portion eventually pays off the entire loan. The buyer also gains equity in the property through principal payments.

How a home equity loan works

A home equity loan is available to anyone who owns a home and owners who have a mortgage. Although this type of loan does not require a downpayment, borrowers must have sufficient equity in their home to meet the loan to value (LTV) requirements.

LTV is simply the sum of the total amount due on a property and its purchase price. This is expressed in percentages. A $400,000 home would have a 50% loan to value ratio if it had a $200,000 mortgage.

Home equity lenders are usually willing to lend enough money to make the property’s total debt up to 80%. This is $400,000 x 80% = $320,000. Add the $200,000 mortgage payment to the purchase mortgage, and you get $120,000. This is the maximum amount that a home equity lender will likely lend on this property.

Home equity loans typically have monthly payments and terms shorter than five to fifteen years. A home equity loan is secured by your home, just like a purchase mortgage. The lender can repossess the property and sell it if the borrower does not make the required payments on the purchase mortgage or the home equity loan.

In this instance, a second mortgage is a home equity loan. This means that if the homeowner defaults, the first mortgage holder will have first rights to the proceeds from foreclosure. Home equity loans are more expensive than purchase mortgages because they are less risky. The home equity loan is a first mortgage if the homeowner is the sole owner of the house.

Borrowers often use home equity loans to consolidate credit cards or other loans with higher interest rates. You can also use home equity loans to pay for college tuition and wedding expenses, as well as other large-ticket items. You can also set monthly amounts, which can help you budget.

Low-cost home equity loans can consolidate and pay off large debts. It would help if you were careful with home equity loans as they can pose a risk to the borrower’s house.

Alternatives to Mortgages, Home Equity Loans

You can also pay cash instead of using a mortgage for a home purchase. The National Association of Realtors estimates that the average home price will reach $362,600 by November 2021. This means that cash payments are not an option for many home buyers.

Rent-to-own is another option to traditional mortgages. These deals require renters to pay an additional amount each month, which is put into an account to fund the down payment on a traditional mortgage. Buyers might be eligible to borrow against an insurance policy, borrow from a relative or get a loan from their retirement account.

A home Equity Line of Credit (HELOC) can be used as an alternative to a Home Equity Loan . HELOC funds are not a one-time payment. Instead, the borrower receives a credit line that they can access. The borrower only pays for the actual money coming out of the credit card.

A cash-out refinance homeowners to tap into their equity. The cash-out refinance a mortgage with a new one. The borrower can borrow more money than necessary to pay off an existing mortgage. This cash can be used for other purposes. A cash-out refinance one advantage: the borrower will only have one payment, instead of two for the purchase mortgage and one for the home equity loan.

Another type of loan that a homeowner can get is the reverse mortgage. These loans can help seniors with cash flow and other financial needs. Reverse mortgages are not a one-time payment. Instead of receiving a lump sum, the lender sends the borrower monthly payments. The lender can take the home if the borrower cannot pay it.