Loan approval
What is Pre-approval for a Mortgage and How to Qualify
April 26, 2021
Mortgage Broker vs. Direct Lender: Finding the Right Loan Partner for You
August 12, 2021
Show all

The Differences Between Mortgages and Home Equity Loans

mortgage loans

Deciding to purchase a home is an exciting time. However, it can also be very stressful if you don’t understand the distinctions regarding mortgages vs. home equity loans. How do you know what’s best for you? When buying real estate, do you choose a fixed-rate-interest loan, and for how long? Or is a variable interest loan better?

You have plenty of questions, and we have the answers to help you decide which loan is right for you.

What Is a Mortgage?

home equity loans

A mortgage is a loan you use to purchase a new home, in which the house itself serves as the collateral. Typically, you can borrow up to 80% of the home’s value, and you will be responsible for independently coming up with a down payment to cover the remaining balance before you can get the mortgage.

Fixed-rate mortgages run for 10, 15, or 30 years, and your payments stay at a fixed rate for the entirety of the loan. Alternately, you can choose a variable interest rate that will change yearly according to the terms of your loan.

What Is a Home Equity Loan?

A home equity loan is an opportunity to borrow against the equity you have earned since purchasing your home. For example, if you bought a house for $180,000 and now it’s worth $200,000, you can borrow against up to $20,000 as a home equity loan. These loans can be at fixed interest rates or as lines of credit with varying interest.

With the equity you’ve earned, you can make repairs on your home, pay off debt, or pay for your child’s education. The interest rates are slightly higher than your mortgage but typically much lower than credit cards or other types of loans.

Types of Mortgages

With so many different types of loans available, our mortgage guide will help you make an informed decision as to which mortgage is right for you.

Conventional Fixed-Rate

A fixed-rate mortgage is a type of loan where the interest rate stays the same for the entire length of the loan, with term options set at 10, 15, and 30 years. A 10-year loan will have a higher interest rate than a 30-year loan but takes less time to pay. You will want to consider this when thinking about how much interest you are willing to pay. The benefit of this popular loan is that you know your payment from start to finish.

Pros:

  • Down payment as low as 3%; requires a mortgage protection insurance (MPI)
  • No PMI with a 20% down payment
  • Second homes/investment properties allowed

Cons:

  • Higher interest rates for lower credit ratings
  • Income limits
  • Higher credit score required for approval

Adjustable-Rate Mortgage (ARM)

An adjustable-rate mortgage starts with a set rate for a set number of years. For example, a 5/1 ARM begins with a lower annual percentage rate (APR) for five years. At the end of the five years, the interest rate will adjust to the APR current in that year.

This type of loan allows buyers to purchase a more expensive home, as the interest rates are lower when compared to a fixed-rate loan, as long as the interest rate does not go up.

Several different options are available so that you can choose how long the fixed rate lasts.

  • 3/1 & 3/3 ARM
  • 5/1 & 5/5 ARM
  • 5/25 ARM
  • 7/1 ARM
  • 10/1 ARM

An adjustable-rate mortgage is excellent for those who do not plan to remain in the home for the loan duration and typically sell before the initial rate expires.

FHA

The Federal Housing Administration (FHA) offers a loan for those who do not qualify for a conventional mortgage, and the down payment requirement is significantly less. This type of mortgage gives low-income families a chance at owning a home without a large down payment or high credit scores.

Pros:

  • 5% down payment
  • Better rates for low-income buyers
  • Lower credit scores OK
  • Lower MPI rates

Cons:

  • If less than 10% down payment, it requires a non-cancellable MPI
  • Certain home types like condos do not qualify
  • Homes must be owner-occupied
  • Loan limits vary by regions

VA (Veterans Affairs)

If you currently serve in the armed forces or are a veteran, you can qualify for this loan that the Department of Veterans Affairs backs. It offers many benefits for our military and their families.

Pros:

  • No down payment
  • No MPI
  • No minimum credit score
  • No prepayment penalty

Cons:

  • Applies to a primary residence only
  • Incurs a VA funding fee
  • Has slower closing times
  • Is eligible only for active duty, reservists, and military veterans

Jumbo Mortgage

Jumbo mortgages are a type of conventional loan for properties that exceed loan limits set by the Federal Housing Finance Agency. In most areas, that limit is currently $548,250. Loans for homes above this limit can’t be guaranteed by federal programs and so pose a higher risk for lenders. They are more common in areas where the cost of living is well above average.

Pros:

  • Allow for much higher purchase limits
  • Interest rates are generally on par with traditional conventional loans

Cons:

  • Requires a 10 to 20% down payment
  • FICO score must be above 700 in most cases
  • Debt-to-income ratio must be under 45%

Types of Home Equity Loans

One of the benefits of owning your own home is borrowing against the equity you’ve earned. If your home value is more than what you owe, the difference is your equity. Our home equity loans guide can help you decide how you might want to draw on the equity you have in your home.

Fixed-Rate

A fixed-rate home equity loan allows you to borrow money against your home’s equity. The interest rates are typically lower than average loans and can help you pay off debt or take a dream vacation. This loan type will have a set number of years, interest rates, and payments that do not change throughout the loan.

HELOC

A home equity line of credit (HELOC) allows you to borrow any amount you need based on your home’s equity. The line of credit operates like a credit card, where you would have a limit you could draw against. However, you would only make payments on the money you borrowed, and the interest rates would vary. Typically, homeowners take out a line of credit when they want to make home improvements and don’t have a firm amount in mind.

Making an Informed Choice About Your Mortgage or Home Equity Loan

Knowing the distinguishing features of a home mortgage vs. a home equity loan can help you make the right decision when you are ready to buy a new home or need to borrow money without paying the high-interest rates of loans or credit cards.

Whether you are looking to buy your first home or need some extra money to help pay the bills, choosing the right mortgage or home equity loan will help you save money and your credit score.

Call 201-265-4545 today to speak with one of our home loan officers at Cornerstone Capital Financial Services to discuss how we can help you make the right decision. We serve Bergen County, NJ, and surrounding communities.