Both a mortgage and home equity loan represent financial investments in your property—but the process and purposes of each are a little different. Usually, you’ll need the equity from your home’s mortgage first before you can qualify for a home equity loan.
If you’re a first-time home buyer, understanding dense real estate jargon can feel like a hefty task. After all, given all the legal and financial aspects of the home-buying process, it’s difficult to know the differences between terms.
Among some of the most commonly confusing real estate words are the terms home equity loan and mortgage. Both a home equity loan and mortgage represent a borrowed sum of money used to invest in your property—but that doesn’t make them interchangeable.
Here to break down home equity loans vs. mortgages is Jerry
, the trusted brokerage app
for home insurance
and car insurance
—your personal real estate translator. Read on to learn the differences between loan types and when you should consider each one. We'll also throw in how to bundle your home and car insurance for even bigger savings, so you can pay off that mortgage in no time. How does a mortgage work?
A mortgage is a financial loan typically provided by a bank or credit union that helps a home-buyer afford and finance a property. To buy a home, you’ll first have to be approved for a mortgage—in most cases, you can finance up to 80% of your home’s value or the purchase price (whichever is lower).
To qualify for a mortgage, you’ll need to meet certain requirements, such as:
A low debt-to-income (DTI) ratio
A minimum down payment price for the property
Solid savings to cover closing costs
All of these factors help show lenders you’re a credible candidate for a loan—and that they’ll eventually see their money returned through your monthly payments. The amount that isn’t financed by your mortgage loan becomes your down payment on the property.
There are several types of mortgages out there—from 15- and 30-year fixed-rate loans to mortgages with an adjustable rate. No matter the type you have, you’ll need a mortgage to ascertain the equity in your home before you can take out a home equity loan.
What is a home equity loan?
A home equity loan, by contrast, is a type of financial loan that uses the existing equity you already have in your home as collateral. Often referred to as a “second mortgage,” a home equity loan requires you to first have a mortgage to qualify. That’s because your equity—that is, the difference between your home’s value and your remaining mortgage balance—is what secures the loan and ensures you’ll pay it back.
Generally speaking, home equity loans are more affordable than mortgages and allow for more variable rates. Most lenders will consider your credit score and DTI when determining your specific rate.
Why take out a home equity loan? Most homeowners use their home equity loans to help consolidate debt at a lower interest rate or make improvements or renovations to their homes. In fact, using your home equity loan to “sustainably build or improve” your property makes one-hundred percent of the loan interest tax-deductible.
Mortgages vs. home equity loans
Mortgages and home equity loans both relate to home ownership and represent a significant investment in a property, but they’re applied in vastly different ways. To summarize:
| |
|---|
Loan used to purchase or finance a home | A “second mortgage” used to finance a home or personal projects; typically uses your existing equity as collateral for the loan |
Require you to have a good credit score, DTI, etc. | Require you to have a good credit score, DTI, etc. |
Lengthy application process and expensive rates | Faster application process, more affordable |
Usually offer higher fixed-rate terms and lower interest | Offer more adjustable terms but higher interest rates |
Alternatives to a home equity loan
We’ve covered the basics of mortgages and home equity loans—but those aren’t the only types of financial loans available to homeowners. These are some other common ways homeowners choose to help finance their property:
Home equity line of credit (HELOC): Similar to a home equity loan, a HELOC lets you borrow money against the equity you have in your home—but instead of borrowing a lump sum of cash, you’re extended a line of credit you can withdraw from while paying minimal interest (but you’ll eventually have to pay it back, like a credit card).
Cash-out refinancing: Need money, but don’t want a second mortgage? You may be able to refinance your existing mortgage loan to secure a lower rate.
Finding affordable home insurance
If you own a home, chances are you have home insurance
—and you’re familiar with just how time-consuming the process of finding a policy can be. After all, finding the best coverage can feel overwhelming! And then there’s the matter of what it costs—but that’s where Jerry
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