Mortgage and Home Equity Loans: The Difference

If you own a home or are thinking about buying a home, knowing the difference between home equity loans and a mortgage is imperative before making a purchase. Both are types of financial transactions that involve the value of a house and how that value is assessed and used.

Home Mortgage

A mortgage is given to a prospective homebuyer when he takes out a loan to purchase a house. The mortgage is the price of the home, plus any fees, closing costs, and taxes, while the house is the collateral. If a homeowner defaults, the bank or whomever owns the loan can foreclose because it is the collateral the loan is based on.

Home Equity

Equity is the value of a home, minus the remaining amount owed on the mortgage. For example, if you have a mortgage for $100,000 on your home, and you have paid off $25,000 of that mortgage, then you have $25,000 equity in your home, as long as the home is still appraised at a market value of $100,000. It is a combination of what the home is worth and how much you owe on the mortgage. If your home’s market value has risen $10,000, instead of having $25,000 equity you would have $35,000 equity.

Home Equity Loan

Home equity loans allow you to borrow against the value of your home based on the market value and mortgage due. It is an additional loan you get after you already have a mortgage on your home. Some lenders use both the term home equity loan and second mortgage interchangeably, but they don’t always mean the same thing. For example, if you have paid off your home, you can still take out a home equity loan because you have value in your home to borrow from. It wouldn’t be a second mortgage because you don’t have a first mortgage. Nonetheless, if you do have a first mortgage, your home equity loan could be considered a second mortgage.

Higher Rates of Interest

A home equity loan still uses the home itself for collateral, but it usually comes second in getting paid off if the home is foreclosed, Therefore, the interest rate on home equity loans is usually more than on a first mortgage. Homeowners also usually need to have an adequate credit rating to get one of these types of loans at a desirable rate.

Different Repayment Plans

Another possibility is if the home equity loan is for a shorter period of time than a mortgage. Most mortgages are for a 30-year term unless you chose a different type, such as a 15-year term mortgage. A home equity loan, on the other hand, is usually for a shorter period of time—10 years is typical for repayment. Pay attention to the terms if you are getting one.