Mortgages are term loans with a fixed or variable rate used to buy or refinance a home.
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A home equity loan is a fixed-rate term loan that taps into a home's equity.
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While home equity loans carry higher rates, they’re ideal for borrowers who want to withdraw cash from their homes without refinancing their existing mortgage.
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Borrowers can select loan terms up to 30 years to match their budget.
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Mortgage interest deduction is limited to $750,000, and home equity loan tax deductions are limited to money spent to buy, build or substantially improve a home.
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What is a mortgage?
A mortgage is a type of loan used to purchase property. The home secures a mortgage, meaning the lender can take the property if you fail to repay the money owed. A typical home loan will have a fixed rate for a 30-year term. These loans often have a fixed monthly payment that reduces the balance over time. At the end of the term, the loan has a zero balance. Mortgages may also have shorter terms, such as 10, 15 or 20 years, or a variable interest rate.
Mortgages are typically used to buy a home or refinance an existing mortgage. Refinancing occurs for many reasons, including pulling cash out, obtaining a lower interest rate, eliminating private mortgage insurance (PMI) or removing a co-borrower.
» MORE: Cash-out refinance vs. home equity loan
What is a home equity loan?
A home equity loan is a second mortgage that taps your home's equity, which is the amount your home is worth minus what you owe. Once the loan is approved, you receive a lump sum. You repay the loan according to a set repayment schedule. These loans have a fixed interest rate, typically higher than a primary mortgage.
Homeowners often use home equity loans to fund home improvements, consolidate debt, start a business or pay for college tuition. Borrowers can choose the repayment term that matches their goals and ability to make the monthly payments. Typical term lengths for home equity loans range from five to 30 years.
The amount you can borrow with a home equity loan varies based on your home's value, your current mortgage balance and the lender's maximum loan-to-value (LTV) ratio. Typically, the maximum LTV ratio for a home equity loan is 80%, including the balance of your primary mortgage. For example, if your home is worth $400,000 and you owe $250,000, your maximum home equity loan would be $70,000.
» MORE: How to use home equity
Differences between a mortgage and home equity loan
Mortgages and home equity loans are similar in many ways but have distinct differences. They are both secured by your home and typically have fixed interest rates throughout the loan term. However, the maximum loan amount, interest rate, tax deductibility and other factors can vary significantly.
Each loan type can be the ideal financing option, depending on a homeowner's goals. In some cases, a homeowner may have both loans to accomplish multiple goals at once.
Casey Fleming, the author of "Buying and Financing Your New Home," said, "If a homeowner's existing first mortgage has a very low fixed interest rate, then a home equity loan (second mortgage) would probably be a much cheaper option in the long run."
This chart highlights the differences and similarities between mortgages and home equity loans.
| Feature | Mortgage | Home equity loan |
|---|---|---|
| Maximum loan amount | None | Varies by lender |
| Maximum LTV ratio | Up to 100% LTV ratio | Up to 80% LTV ratio, varies by lender |
| Interest rate | Fixed or variable | Fixed |
| Loan term | Typically 30 years, but 10, 15, 20 or 25 years are also available | 5 to 30 years |
| Tax deductibility | Up to $750,000 | Up to $750,000 (combined with the primary mortgage), but only when used to buy, build or improve the home |
» COMPARE: Best Mortgage Lenders
FAQ
Is a home equity loan a second mortgage?
Home equity loans are typically second mortgages behind your primary mortgage. These loans are in second position in case of default, so they have a higher risk of not being repaid if your home is foreclosed on. For that reason, home equity loans usually have a higher interest rate than a purchase or refinance mortgage.
What is a home equity line of credit?
A home equity line of credit is a flexible borrowing tool that allows homeowners to tap their home's equity. You have a maximum borrowing limit and only pay interest on the amount drawn from the line.
During the draw period, you'll have interest-only payments based on your average balance. You can draw down and repay the balance as often as you like. After the draw period expires, the loan converts to an amortizing loan with a fixed interest rate.
Do home equity loans have adjustable rates?
One of the main features of a home equity loan is its fixed interest rate. Having a fixed interest means a consistent monthly payment that homeowners can budget around. These loans have a defined repayment term, and as long as you make all your payments on time, the loan has a zero balance at the end.
Bottom line
Homeowners have many choices when tapping their home's equity. When comparing a home equity loan vs. a mortgage, each type of loan has distinct advantages for homeowners. Both loan types typically offer a fixed interest rate with stable monthly payments and terms of up to 30 years. However, home equity loans usually carry higher interest rates and lower maximum LTV ratios than mortgages.
As a borrower, you can often choose to use both types of loans by keeping your current mortgage and applying for a home equity loan to tap into your home's equity. This allows you to keep your current mortgage interest rate and terms. Then, you can select a loan amount and repayment term for your home equity loan that matches your needs and budget.
Article sources
ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
- Bank of America, " Home equity loan vs. line of credit? Here’s what you need to know." Accessed Feb. 28, 2024.
- U.S. Bank, "Second mortgage vs. home equity loan." Accessed Feb. 28, 2024.
- U.S. Bank, "Help fund life’s big moments by unlocking your home equity." Accessed Feb. 28, 2024.
- U.S. Department of Veterans Affairs, "Purchase loan." Accessed Feb. 28, 2024.
- JPMorgan Chase & Co., "Choosing a mortgage term." Accessed Feb. 28, 2024.
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