Mary Beth Eastman 
Key Takeaways
- A mortgage is a way to purchase a home using the home as collateral.
- A home equity loan is a loan option for homeowners who want to borrow money using their home equity as collateral.
- A home equity is sometimes also called a second mortgage.
- Defaulting on either a mortgage or a home equity loan puts you at risk of losing the home.
Did you know when you began your homeownership journey that you’d have to learn so many new terms? It’s easy to understand what a home loan is – borrowing money to buy a home. But then what is a home equity loan, and how does that compare to a mortgage loan?
A mortgage loan is a home loan. It helps you buy a home by putting the house itself down as collateral. A home equity loan is a little bit different. It uses the equity you’ve built in your home as collateral for borrowing money for another purpose. Another way to look at it: A mortgage loan is for buying a home now; a home equity loan is for borrowing against your home later.
It’s normal to still feel a little uncertain about these terms and what they mean for your situation. We’ll go over the details of each one, including pros and cons and the best use for each. By the end of this article, you’ll have a good idea of which one is right for you – or if you need something else altogether.
What is a Mortgage Loan?
A mortgage loan is the most common method of buying a home. You apply for credit with a lender, promising to put up the home itself as collateral. If you fail to repay the loan, the lender can take the home to satisfy the debt.
Even with the recent rise of all-cash homebuyers, 74% of homes are purchased with a mortgage, according to the National Association of Realtors. A mortgage allows you to spread out the cost of buying real estate over an extended period, usually 15 or 30 years. Fixed-rate mortgages, where the rate and payment stays the same each month, are most common. After you’ve made all of your mortgage payments, the loan is paid off and the home is yours – you now own it outright.
One thing you may not realize is that a refinance is also a mortgage loan. So if you choose to refinance your home, that means getting a new mortgage to replace your current mortgage.
What is a Home Equity Loan?
A home equity loan (often abbreviated HEL) is a loan that typically gives you a lump sum of cash up front, using your home equity as collateral. A home equity loan can give you access to a greater amount of cash than other types of loans since you have an asset (your home) to secure it.
Home equity loans are typically longer-term loans ranging from 5 to 30 years. They often use fixed interest rates and fixed payments, so you pay the same amount each month.
The size of the loan is based on the amount of equity you have. Equity is the amount of ownership you have in the home – how much of it you own yourself, compared to how much the bank still owns. You can calculate your home equity by subtracting the remaining mortgage balance from the home’s value. If the house is worth $500,000 and you still have $400,000 left on the mortgage, you have $100,000 in home equity.
Because they help you borrow larger amounts of money, home equity loans are often used to help pay for big projects like home renovations.
Key Differences Between a Home Equity Loan and a Mortgage
Although both a home equity loan and a mortgage use your home as collateral, they have a few key differences. Here are the most important factors to know about a home equity loan vs. a mortgage.
| Mortgage Loan | Home Equity Loan | |
|---|---|---|
| Primary Purpose | Buying a home | Borrowing money |
| Timing | At the time of a home purchase | After you’ve built equity |
| Loan position | Primary | Secondary (riskier for lender) |
| Loan amount | Up to the purchase price | Limited by available equity |
| Loan term | Usually 15 to 30 years | Usually 5 to 15 years |
| Interest | Often fixed, although adjustable rate mortgages available | Usually fixed, may be higher than mortgage rates |
Can you get a home equity loan if you have a mortgage?
Yes, you can get a home equity loan even if you currently have a mortgage on your house. The mortgage is considered the primary lien, and the home equity loan is the secondary lien. That means if you default and stop paying both loans, the home would be sold and the proceeds would first go to repaying the mortgage and then, if there were funds left over, go toward repaying the home equity loan.
This secondary position means the home equity lender takes on a little more risk, which is why interest rates for home equity loans are sometimes a bit higher than mortgage rates.
If you have a mortgage on your home but also a lot of equity, you can borrow against that equity without having to sell your home by taking out a home equity loan. It’s a way to benefit from the gain in value while still living in the home.
The pros and cons of each option
Each loan type has its benefits and disadvantages.
Mortgage loan pros and cons
You would typically use a mortgage if you wanted to buy a home.
Pros:
- Long repayment terms
- Lower interest rates
- Makes homeownership possible
- Refinancing is an option for changing loan terms
Cons:
- Large, long-term commitment
- Usually require significant closing costs
- Often require a down payment
- Defaulting on the loan can lead to foreclosure
Home equity loan pros and cons
You can only borrow against your home equity if you own the home first (whether you have a mortgage or not).
Pros:
- Can be a smaller loan amount and shorter term than a mortgage
- You can borrow while keeping your same mortgage rate
- Access to a large sum of money
- Rates often lower than unsecured, personal loans
Cons:
- You must have built some equity in the home first
- Tends to have higher rates than a mortgage
- Adds another monthly payment, which could stretch your budget
- Also puts your home at risk if you default
When does a home equity loan make sense?
A home equity loan can be a useful tool in many situations. It often makes sense if you:
- Have owned your home for some time: It’s generally not suitable for someone who just bought a home.
- Have at least 20% equity in your home: If you have less than 20% equity, you risk becoming underwater if home values decline.
- Have a specific, planned expense in mind: A home equity loan isn’t the best route if you are looking for more flexible access to cash.
- Want a lower interest rate than you’d get for a personal loan: Home equity loans often have lower rates because they’re secured by your home, reducing the risk for the lender compared to a personal loan.
- Want to preserve a low mortgage rate: If you like your current mortgage but still need to borrow, a home equity loan provides access to cash without refinancing into a new mortgage.
- Have good credit and don’t mind another monthly loan payment: If you prefer a method of tapping home equity that doesn’t require perfect credit or monthly payments, you might prefer an option like Unlock’s home equity agreement (HEA). An HEA from Unlock gives you access to your equity without adding more monthly obligations.
Conclusion
If you’re looking to borrow money to buy a home, a mortgage loan is the right choice. But if you already own a home and need to borrow money for other purposes, such as a home remodel or unexpected medical bills, a home equity loan is one solution. Just keep in mind that you’ll still need to apply for the home equity loan, so you’ll need decent credit and sufficient equity to qualify.
FAQs
Yes, a home equity loan is often called a second mortgage. The mortgage you used to buy the home is considered the primary mortgage, and that lender would be repaid first if your creditors had to foreclose on your home for nonpayment.
The home equity loan lender would be second in line, which is why it’s considered a second lien and not a first lien (a lien is a legal claim to a debt).
Yes, you can. Many people use a mortgage to purchase their home, and then later, after they’ve built some equity, use a home equity loan to borrow against that equity. Just keep in mind that if you have a mortgage and a home equity loan, that means you’ll have both a mortgage payment and a home equity loan payment every month.
The exact credit score you need for a home equity loan will vary depending on the lender. However, most lenders will require a score of at least 620 to qualify and you may need a score of 680 or higher for better rates.
Failure to repay a home equity loan can have serious consequences, including foreclosure and the loss of your home. Since you put your home as collateral on the home equity loan, the lender is within its rights to take the home as payment. It’s smart to take a close look at your budget and see what you can realistically afford before taking out a home equity loan.
If something unexpected happens after you take out the loan, it’s always a good idea to talk directly with your lender. They may be able to work out a payment plan that works for you before foreclosure is on the table.
Besides the risk that you could lose your home for failure to repay the loan, there are some other risks to be aware of, too. Adding a home equity loan means adding another, sometimes sizable, payment to your monthly budget. It reduces your equity, which could affect your profits if you have to sell the home sooner than you planned. And since rates are higher than some other types of loans, it may not be the cheapest option if you need to borrow money.
