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Mortgage Vs. Home Equity Loans

When you are looking to purchase a house, you will probably think of a mortgage to do so. A mortgage is when a financial institution lends money to a borrower to buy a home. After you borrow a mortgage, that stake in the house becomes your equity. A home equity loan is also a mortgage. The principal difference is that you take out a home equity loan after buying and accumulating equity in your home.

Traditional Mortgage

A mortgage is a loan to help you finance a house. Mortgage lenders have requirements that borrowers need to meet in order to be approved for a loan. These requirements involve:

  • A minimum down payment
  • A minimum credit score
  • A debt-to-income (DTI) ratio that shows you earn enough money to cover other expenses
  • Enough money to cover closing costs on the mortgage

The most usual type of mortgage is a 30-year fixed-rate loan. However, there are other options available for borrowers, such as 15-year fixed-rate loans.

Home Equity Loan

A home equity loan comes later while you are still paying your mortgage or if you have already paid it off in full. If you are sill paying your mortgage, a home equity loan is a type of second mortgage. This allows you to use the equity in your house to borrow more money.

As an example, let’s say your home is worth $250,000, and you owe $1500,000. You have $100,000 of equity in your home. So you can use that equity as the collateral for a loan. You can borrow up to 80% or 85% of your equity.

Mortgage Vs. Home Equity Loan

With both a mortgage and a home equity loan, you are borrowing money and committing to repaying it. In case you are not able to pay it back, the lender can take your home, since it is the collateral for both of these types of loans.

5 types of mortgage loans. Click here to read more.

What is a second mortgage?

A home equity loan is a second mortgage. It might be interesting to understand why someone would want a second load of debt to pay back. Mortgage rates tend to be lower than other products such as credit cards or personal loans. This is because you are putting your home on the line to borrow the money. So they are a less expensive type of loan overall.

If the house goes into foreclosure, until the first mortgage lender is paid, the lender holding the home equity loan does not get paid. Therefore, the home equity loan lender’s risk is greater. That is why these loans generally carry higher interest rates than traditional mortgages.

Some borrowers use second mortgages to pay for improvements or renovations on their homes. They can also be used to pay other major expenses like college tuition.

Bottom Line

When you need to borrow money, your home can serve as the collateral to access the cash. However, if you fail to make payments on a mortgage or a home equity loan, the lender has the right to take ownership of your house.

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