Before we start comparing the two, what exactly is the difference between mortgages and home equity loans?
Home equity loans and mortgages are both borrowing methods that require pledging a home as collateral, or backing, for your debt. This means that your lender can seize the property eventually, if you don’t keep up with your repayments. While both the loan types share this similarity, there are subtle key differences between the two.
When using the term ‘mortgage’, people generally refer to traditional mortgages, in which a financial institution, such as a bank or credit union, will lend money to a borrower to purchase a residence. Usually, the bank lends as much as 80% of the home’s value or the purchase price, whichever costs less.
A home equity loan is also technically a mortgage, with the main difference being that you take out a home equity loan after buying and accumulating equity in the property. A mortgage is usually the lending tool that lets a buyer purchase, or finance the property in the first place.
A home equity loan, as the name suggests, is secured by a homeowner’s equity in the property, which is the difference between the value and the existing mortgage balance of the property.
Just like a traditional mortgage, a home equity loan is an installment loan that is repaid over a fixed term. Various lenders have different standards about the percentage of a home’s equity they are willing to lend, with the borrower’s credit rating helping to inform this decision.
If you have a very, very low-interest rate on your existing mortgage, you should probably use a home equity loan to borrow the extra funds that you need. You should, however, keep in mind that there are limits on its tax deductibility, which include using the money for improving your property and other such purposes. If your mortgage rates have dropped substantially since you took out your current mortgage, or even if you need the money for purposes unrelated to your home, you could also consider a full mortgage refinance. If you choose to refinance, you can save on the extra money you borrow, as a traditional mortgage carries lower interest rates than a home equity loan, and you may even be able to get a lower rate on the balance you already owe.