You’ll likely hear the terms home loan and mortgage used interchangeably, but home loan covers a variety of mortgages, home refinances, and home equity loans.
This piece will focus on the difference between a typical mortgage, used to buy a home, and home equity loans, which are used to tap the equity you’ve gained.
What Is a Mortgage?
Mortgages are loans used when buying a home or other real estate. When you take out a mortgage, your lender is allowing you to borrow the money you need to buy a home in exchange for charging you interest. You’ll repay the loan and interest in monthly installments.
Mortgages are secured loans, meaning the property is used as collateral. If you fail to make mortgage payments, your lender can foreclose on the home to recoup its money.
In order to take out a mortgage, you’ll typically need to make a down payment equal to a percentage of the purchase price. Your down payment is the portion of the cost of the home that you aren’t financing and provides immediate equity in the property.
Buyers may put down 20% on conventional mortgages to avoid private mortgage insurance (PMI), but many buyers put down much less. In fact, the median down payment for all homebuyers was 13% in 2021, according to a National Association of Realtors® report. A mortgage calculator can help you determine what effect the size of your down payment will have on your monthly payments.
When shopping for a home, you can seek mortgage pre-approval. After investigating your financial history, your lender will provide you with a letter stating how much money you can likely borrow and at what interest rate.
Types of Mortgages
There are several types of mortgages available. Mortgage insurance, in the form of PMI or mortgage insurance premiums (MIP), may be part of the deal. It’s good to understand PMI vs MIP.
• Conventional mortgages are funded by private lenders like banks and credit unions. They are not backed by a government agency. You’ll typically need to pay PMI if you don’t make a 20% down payment; mortgage insurance is canceled when 22% equity is reached. Conventional conforming loans adhere to lending limits set each year by the Federal Housing Finance Agency.
• Jumbo loans are mortgages that exceed the lending limits set for conventional loans. So a jumbo loan is a “nonconforming” loan. Conventional lenders issue jumbo loans, and the Department of Veterans Affairs guarantees a VA jumbo loan, possibly with no down payment.
• FHA loans are made by private lenders and guaranteed by the Federal Housing Administration. You may qualify to make a down payment of as little as 3.5%. Upfront and annual MIPs are required, usually for the life of the loan.
• USDA loans are backed by the U.S. Department of Agriculture and help low- to moderate-income households buy property in designated rural and suburban areas. No down payment is required. An upfront and annual guarantee fee are required.
• VA loans are designed for active-duty and veteran military service members and some surviving spouses. VA loans don’t require a minimum down payment in most cases. There’s no MIP; there is a one-time funding fee.
What Is a Home Equity Loan?
A home equity loan is frequently known as a second mortgage. Home equity loans allow homeowners to borrow against the portion of their home they own outright.
As with typical mortgages, home equity loans are secured using the home as collateral.
The amount you’re able to borrow will be determined by a few factors, including your credit history and how much equity you’ve built: the current value of your house less any outstanding debt.
It’s common for lenders to allow you to borrow up to 80% of the equity you’ve established. The loan arrives in a lump sum. You repay the home equity loan with interest over a set period of time. If you miss payments, your lender can foreclose on the house.
The borrower may pay closing costs based on the loan amount.
Another way to tap home equity is with a cash-out refinance, when you take out a new loan to pay off your old one and free up equity.
Similarities Between Home Equity Loan and Mortgage
When you apply for a mortgage as part of the home-buying process, or a home equity loan as a homeowner, lenders will look into your financial history to help them establish terms and the interest rate for the loan. For example, they will examine your credit reports, often awarding more favorable terms and interest rates to those with higher scores.
Mortgages and home equity loans are both secured loans.
Differences Between Home Equity Loan and Mortgage
A mortgage must be used to purchase an intended property. There are fewer limitations on the money received from a home equity loan.
Mortgage interest can be deducted if you itemize your deductions. However, you can only deduct interest on a home equity loan if you use the loan to buy, build, or substantially improve your main or second home. So if you want to buy a boat, that deduction won’t hold water.
When You Should Consider a Mortgage
If you don’t have the cash to buy a home outright, you will have to finance the purchase with a mortgage. However, there are some considerations you may want to take into account. For example, the larger your down payment, the more equity you will have in your home and the smaller your monthly mortgage payments will be.
Because you have more equity in the home, the bank will see you as less risky. As a result, larger down payments also tend to translate into lower interest rates. So, consider putting down as much as you can afford to.
Also, even if you have the cash to pay for a home in full, you may consider a mortgage anyway. You may not want to tie up cash that could be used for other purposes, such as in an emergency. You may be able to invest that money and earn a return that’s higher than the interest rate you’d pay on the loan.
When You Should Consider a Home Loan
Many people choose to take out home equity loans to make home improvements. That can increase the value of your home, putting you ahead if you ever choose to sell.
You may also consider a home equity loan when consolidating other debt, including high-interest credit card debt. The average interest rate for a home equity loan remains significantly lower than the average credit card rate. As a result, it can make financial sense to pay off the more expensive debt with a new, cheaper loan.
Home Loans With SoFi
Home equity loan vs. mortgage? One uses a home as a tool; the other gets a buyer into a home. If you’re looking for a home equity loan, a mortgage, or a refinance, it’s a good idea to compare rates and terms.
Give SoFi’s menu of home loan options a look. SoFi offers fixed-rate mortgages and refinancing at competitive rates, and home equity loans through Spring EQ.
Check your rate with no effect on your credit score.*
FAQ
Is a home loan the same as a mortgage?
Yes. “Home loan” is an umbrella term that covers a wide variety of mortgages, home equity loans, and home refinances.
Why is a home loan called a mortgage?
“Mortgage” comes from the old French mort gage, meaning a death pledge — a morbid origin for the pledge you make to a lender to pay back the money you borrow.
Is a mortgage cheaper than a home loan?
Mortgages are a type of home loan. Your interest rate will depend on the type and size of your loan, your down payment, and your financial history, such as your credit score.
Photo credit: iStock/Brandon Ruckman
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