What's The Difference – Home Equity Loan vs Mortgage

Both mortgages and home equity loans are secured by property as collateral, but that’s where the similarities end. Unsure which option best suits your needs? Understanding the characteristics of both loans is essential for making the right financial decision.

In this article, we break down the key differences between a mortgage and home equity. You will know exactly how each works, what the benefits and risks are, and when to choose one over the other.

Don't let uncertainty hold you back. Learn the essentials to take control of your home financing strategy.

What Are Mortgages?

A mortgage is a loan used to buy or refinance a home, where the home you’re purchasing is used as security for the loan. When somebody wants to buy a property, but they can’t pay the full price upfront, they usually take out a mortgage. Essentially, the homebuyer pays a portion of the home's price as a down payment, and a bank or another financial institution lends the remaining money.

There are 2 basic types of mortgages:

1. Conventional: a loan through a private lender, typically requires a minimum of 3.5% to 5% for a down payment. The terms and interest rates can vary widely depending on the borrower's credit score and financial history. Conventional loans that have less than a 20% down payment usually require private mortgage insurance (PMI), which protects the lender in case the borrower defaults.

2. Government-backed: these include Federal Housing Administration (FHA) mortgages which let you put as little as 3.5% down. These are popular among first-time homebuyers because they have more lenient credit requirements and lower closing costs compared to conventional loans. 
   

The terms of a mortgage, including the loan amount, interest rate, and repayment period, are influenced by factors such as the borrower’s creditworthiness, the type of property, and the economic environment.  Borrowers must undergo a rigorous approval process, where lenders check their income, debt, credit history, and other financial factors.

How They Work

When you buy a home with a mortgage, you make what is known as a down payment - a portion of the home’s price - and borrow the remaining cost from a lender. You then repay this loan over a designated period, typically 15 to 30 years, through regular monthly payments that include both the principal and interest.

In the early years, a bigger chunk of your payment goes towards the interest – this is the cost of borrowing the money. As you keep making payments, a greater portion gradually starts chipping away at the principal—the original amount you borrowed. This process is called amortization.

There are also costs that come with getting a mortgage. These include origination fees, appraisal fees, and possibly private mortgage insurance if the down payment is less than 20% of the home’s price. You should also be aware of any prepayment penalties - some lenders charge fees if a loan is paid off early. For further insights, you might want to explore our post, "Mortgages: All You Need to Know"

What Are Home Equity Loans?

Unlike a traditional mortgage, which is used to buy a home, a home equity loan allows you to borrow money against the value of a home you already own. Simply put, equity is the difference between what your home is worth and how much you owe for it. For example, if your home is valued at $300,000, and you still owe $200,000 on your mortgage, you’ve got $100,000 in equity. A home equity loan allows you to borrow a portion of that equity—usually as a lump sum—at a fixed interest rate.

Let’s say you want to renovate your kitchen, buy foreign real estate or pay for your child’s education. A home equity loan might be a good option because the interest rates are typically lower than personal loans or credit cards. 

That’s also the key difference between the two loan types: home equity can be used for purposes both related and unrelated to property.

How They Work

A home equity loan is a lump sum of money advanced to you by the lender based on a certain percentage of your home's equity. Most lenders, however, will allow you to borrow about 80% to 85% of the total equity in your home; it could be less depending on your credit and financial situation.

Once approved, the entire amount of the loan is then disbursed, and you are to start repaying the loan through constant fixed monthly installments. Monthly payment installments include both principal and interest over the years, spanning from 5 to 30 years.

Unlike variable-rate loans, a home equity loan comes with a fixed interest rate, meaning your monthly payment amount stays the same throughout the life of the loan. Such predictability can come particularly in handy if you're keen on being able to budget well into the future.

In addition, you can enjoy lower interest rates compared to unsecured loans like credit cards since the loan is secured by your home. However, you should keep in mind that failure to make payment would lead to a foreclosure of your home by the lender, so borrow responsibly.

Which One Should I Go For?

The answer to this question really depends on 2 things: where you are in your home ownership journey, and what you need the loan for. Let’s break down both options and see which one might fit into your plans. 

When a Mortgage Makes Sense

It’s as simple as this: you’re looking to buy a home and you don’t have the full amount upfront. For example, let’s say you’re buying a $400,000 house. You might put down 20% ($80,000) and take out a mortgage for the remaining $320,000.

Mortgages are also more affordable than other loans because they offer lower interest rates, as well as lower monthly payments. This makes them ideal for first-time owners. 

A mortgage is also an intuitive choice if you’re looking to refinance. Refinancing means swapping your existing mortgage for one that offers a better interest rate, lower monthly payments, etc. 

In short, if your goal is to buy a new home or replace an existing mortgage with better terms, a mortgage is the way to go. You’ll be paying for a long time, but this option spreads out the cost and gives you time to build equity and financial stability.

When a Home Equity Makes More Sense

A home equity loan is a good option if you already own a home and have built up some equity over time. These loans are typically used for big expenses, and not necessarily related to real estate. You can remodel your kitchen, send your children to college abroad, or pay off your credit card debt. 

One of the biggest perks of home equity is you get a lump sum, so you have immediate access to cash. Home equities also offer a low, fixed interest rate, which is often cheaper than other loans. 

You just have to make sure that you qualify for a home equity loan in the first place. Typically, you’ll need to have at least 15%-20% in equity and a credit card score of around 620 or higher. 

However, keep in mind that your home is on the line. If you can’t keep up with the payments, the lender could foreclose on your property. So, it’s important to make sure the monthly payments fit your budget.

Home Equity Loan vs HELOC (Home Equity Line of Credit)

With a home equity loan, you borrow a lump sum up front and make fixed interest rate and payment loans for a set term—usually 5 to 30 years. A HELOC works more like a credit card in that you don't get all your money upfront, instead you have a line of credit that you can borrow from as needed up to a set limit.

With HELOCs, there’s usually a draw period of 10 years during which you can borrow from your line. Then comes the repayment period, when you should pay back the amount that was borrowed.

It all boils down to flexibility. If you need one large sum of money at a time, the home equity loan is better. If you need access to money over time for projects or uncertainty, go with a HELOC. 

Frequently Asked Questions

1. What’s the main difference between a mortgage and a home equity loan?

A mortgage is generally for a home, while a home equity loan allows you to borrow against the equity in a home you already own. While a mortgage is meant for purchasing, the purpose of a home equity loan is to lend against the value you've built up in your property.

2. Can I use a home equity loan to buy another property?

You can use it for any purpose, such as buying another property or other major expenses. This is because you borrow a lump sum of money by taking out a loan against the equity in your current home.

3. Which one offers better interest rates—mortgages or home equity loans?

Mortgages generally carry lower interest rates, especially for first-time homebuyers. 

4. Do I need a down payment for a home equity loan? 

No, you don't have a down payment on a home equity loan; the loan is given against your built-up value in the house.

5.  Is a mortgage or home equity loan better for renovating your house?

The home equity loan goes hand in hand with home renovations. With borrowing against the existing value of your home, it offers funds that are actually invested back into the property. 

Conclusion - Secure Your Ideal Mortgage with Kredium

A mortgage is the loan you take to purchase a property, while home equity lets you use the value you've built in your home over time to make all kinds of investments. Both present their advantages and risks, and making an informed decision will help you manage your finances more effectively and ensure long-term stability.

If you feel like a mortgage aligns better with your international real estate needs, schedule your consultation with Kredium today. We’ll get you the very best loan offers, tailored to your needs, and make the entire process seamless and efficient.

If you need help navigating your mortgage options, Kredium can be your partner on this journey. As your trusted mortgage broker, we compare financial terms, find the best loans for your particular situation and make the entire process seamless. Reach out today and make the first step towards becoming a homeowner!

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