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Home Equity vs. Mortgage: What's the difference?
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When financing a home, terms like "home equity" and "mortgage" are often used, but they can be confusing, especially for first-time homebuyers. Understanding the differences between these two concepts is essential to make informed financial decisions.
This article will explain the distinctions between home equity loans and mortgages, helping you navigate the world of home financing.
What is a Mortgage?
A mortgage is a loan against property specifically used to purchase a home. It's a type of secured loan, meaning that the property itself serves as collateral for the loan. If the borrower fails to make the required payments, the lender can foreclose on the property and sell it to recover the loan amount.
Mortgages typically have long repayment terms, ranging from 15 to 30 years. The home loan is repaid monthly, including principal (the original loan amount) and interest. Various types of mortgages are available, including fixed-rate mortgages, where the interest rate remains the same throughout the loan term, and adjustable-rate mortgages (ARMs), where the interest rate can change over time.
What is a Home Equity Loan?
Home equity loan
Home equity loan refers to the portion of your home you own outright, free of mortgage. It's calculated as the difference between your home's current market value and your mortgage's outstanding balance.
Home equity increases as you pay your mortgage or as your home's value appreciates over time. It represents a significant asset that can be leveraged for various financial purposes, such as taking out a home equity loan or a home equity line of credit (HELOC).
Key differences between Home Equity and Mortgages
Differences Between Home Equity and Mortgages
The following are some of the essential differences between mortgage loans and home equity loans:
- Purpose and Nature
- Mortgage: A mortgage is a loan available to buy a home. It's a liability, meaning you owe a lender money.
- Home Equity: A home equity loan is an asset. It's the portion of the property you own outright, representing the financial stake in your home.
- Loan vs. Value
- Mortgage: The mortgage amount is determined by how much you need to borrow to purchase the home, usually after your down payment.
- Home Equity: Home equity is determined by the amount of the mortgage paid off and how much your home has appreciated since you purchased it.
- Financial Flexibility
- Mortgage: A mortgage is used solely for purchasing property, and the terms are set at the beginning of the loan. The borrower is expected to make regular payments until the loan is fully repaid.
- Home Equity: Home equity can be accessed through financial products like home equity loans or HELOCs. These allow homeowners to borrow against their equity for various purposes, such as home improvements, debt consolidation, or other significant expenses.
- Interest Rates
- Mortgage Interest Rates: Mortgage interest rates are typically lower than other types of loans because the property secures them. The rate can be fixed or variable.
- Home Equity Loans and HELOCs: The interest rates on home equity loans and HELOCs are generally higher than those on primary mortgages but lower than unsecured loans like credit cards or personal loans.
- Using Home Equity Homeowners often leverage their home equity to access cash for significant expenses. There are two primary ways to do this:
- Home Equity Loan: This is a lump-sum loan based on the equity you have in your home. It typically has a fixed interest rate and is repaid regularly over a set term.
- Home Equity Line of Credit (HELOC): A HELOC is a revolving line of credit that you can draw up to a specific limit as needed. It works similarly to a credit card, with interest only on the amount borrowed. HELOCs usually have variable interest rates.
Final Thoughts
In summary, a mortgage is a loan against property you avail of to buy a home, while home equity represents the portion of your home that you own outright. Understanding the key difference between these two concepts is essential for making informed decisions about home financing.
To learn more about the loan rates for both residential and commercial use, visit IIFL Home Loans and complete the online loan application.
FAQs
Q1. What distinguishes home equity from a mortgage?
A home equity loan uses the equity in the house to pay for certain expenses, whereas a mortgage is used to buy the property. Both mortgages and home equity loans often have cheaper interest rates on more significant loan amounts when compared to alternative credit options.
Q2. What does the term "home equity loan" mean?
A home equity loan, also known as an HEL is a loan in which the value of your house can be used as security. Equity is the difference between your home's current value and any mortgage's outstanding balance.
Q3. Which is preferable, loans or equity?
Equity financing might be less risky than debt financing, as there is no collateral or loan to repay. However, regular debt repayment might negatively impact your company's cash flow and growth prospects.
Q4. What is the home equity margin?
Your lender's addition to the prime rate is known as the margin, typically fixed for the duration of the loan. The margin normally ranges between 1% and 5%.
Q5. Why is equity preferable?
The primary benefit of equity financing is that the funds obtained through it are not subject to repayment obligations. However, the disadvantage of equity financing can be significant as it doesn't add to the company's financial burden.
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