Home equity loans and mortgages are both ways to borrow using your home, but they serve very different purposes. Mortgages help you buy a home, while home equity loans let you borrow against the equity you’ve already built. Knowing the difference can help you choose the option that best fits your financial goals.
How home equity loans work
A home equity loan lets you borrow against the value you’ve built in your home—without having to sell. Your loan is given as a lump sum, typically with a fixed interest rate and repayment terms ranging from five to 30 years.
Lenders calculate your available equity by subtracting what you owe on your mortgage from your home’s current market value.
How home equity loans differ from HELOCs
A home equity loan gives you one fixed amount up front, with steady monthly payments. A home equity line of credit (HELOC), on the other hand, acts more like a credit card tied to your home. It lets you borrow, repay, and borrow again during the draw period.
Is a home equity loan the same as a mortgage?
While home equity loans and mortgages are loans that use your home as collateral, they’re not structured the same way. A mortgage is the primary loan you take out to purchase a home. It’s not uncommon for you to repay it over 15 or 30 years.
A home equity loan lets you take out the value you’ve built in your home—both from paying down your mortgage and from market value increases. Terms usually range from five to 20 years but may go up to 30 or more years.
Home equity loan rates vs. mortgage rates: which are lower?
In most cases, mortgage rates are lower than home equity loan rates. Securing a low, fixed-rate mortgage can save tens of thousands of dollars over the life of a loan. That’s especially true when borrowing large amounts to purchase or refinance.
Mortgage loans, such as conventional home loans, generally have lower interest rates than home equity loans because there’s less risk for lenders. If you default on your loan, they have first claim on your property to repay the loan.
Home equity loans are usually second in line to get paid when a property is in foreclosure, increasing the lender’s risk of not being fully repaid. However, even if your house is paid off and your home equity loan is the first lien, rates still don’t usually drop down to primary mortgage levels.
While home equity loans are slightly more expensive, they still offer rates that are usually much lower than personal loans or credit cards.
When to use a home equity loan vs. a mortgage
If you’re purchasing a home or refinancing your existing loan, you’ll need a mortgage. Because it’s a primary loan, you’ll often get the lowest available interest rates and the longest repayment terms.
Refinancing through a new mortgage may also help you lower monthly payments or lock in better terms if rates are favorable.
A home equity loan might make more sense when you need extra funds but don’t want to disturb your current mortgage through refinancing. You might use the cash to do the following:
- Renovate or upgrade your home
- Pay college tuition for yourself or your children
- Consolidate high-interest debt
- Pay for major medical expenses
- Fund large one-time purchases, like a wedding
- Make a down payment on a second home
- Fund business ventures
However, because the money is borrowed against your home equity, most experts recommend reserving it for expenses that improve your financial footing or add value to your home.
Home equity loans: Pros and cons for homeowners
Like any financial tool, home equity loans have their benefits and drawbacks. Here are the most important ones to consider.
Pros
- Lower interest than personal debt
- Fixed lump sum for major projects
- Potential tax-deductible interest
Cons
- Reduces long-term home equity
- Risk of foreclosure if unpaid
- Closing costs and added debt burden
For homeowners without thousands available in savings, a home equity loan can be an affordable way to fund major expenses.
Rates are often much lower than personal loans or credit cards, and the lump sum makes it ideal for renovations that increase your home’s value. In some cases, the interest may also be tax-deductible if the funds go toward home improvements.
But tapping into your home equity reduces the wealth you’ve built in your home, and closing costs can eat into the benefits. Taking on an additional loan also increases your overall debt load. If financial setbacks occur, falling behind on payments could ultimately put your home at risk.
Making the best decision for your family and home
Choosing between a home equity loan and a mortgage comes down to how you plan to use the funds. A mortgage is the foundation for purchasing a home and usually provides the lowest rates and longest terms. It’s the go-to choice for most buyers.
In comparison, a home equity loan gives you access to the value you’ve already built in your property. It’s useful for targeted needs, such as renovations or helping to buy a second home.
If buying or selling is in your future, Clever can help you take the next step with confidence. Clever connects you with top local real estate agents from major brokerages, but at a fraction of the traditional commission. You get full-service support while keeping more money in your pocket. Get matched to local Clever agents today.