What is the difference between home equity loan and mortgage

last reviewed: SEP 04, 2020

With a home equity loan, you receive the money you are borrowing in a lump sum payment and you usually have a fixed interest rate. With a home equity line of credit (HELOC), you have the ability to borrow or draw money multiple times from an available maximum amount.

Unlike a home equity loan, HELOCs usually have adjustable interest rates.

If you are having trouble paying your mortgage, before taking out a home equity loan or home equity line of credit, talk to a housing counselor to see if there may be other options that make better financial sense for you. Call the CFPB at (855) 411-CFPB (2372) to be connected to a HUD-approved housing counselor today.

To get a home equity loan, you’ll need to qualify, which means your lender will examine your equity, credit score and debt-to-income ratio. These three elements are all taken into consideration so if you’re weak in one area, the other two can help boost your qualifications.

Equity And Home Appraisals

To determine whether you qualify and how much money you can borrow, a lender will have your home appraised. The home appraisal will tell the lender how much your home is worth.

Rocket Mortgage will allow you to borrow around 90% of the equity in your home. To figure out the amount you could obtain through a home equity loan, you’d determine your loan-to-value ratio. To do this, subtract the remaining balance of your primary mortgage from 90% of the appraised value of your home. For example, if your home is appraised at $400,000 and the remaining balance of your mortgage is $100,000, here’s how you would calculate the potential loan amount:

$400,000 x .9 = $360,000

$360,000 – $100,000 = $260,000

This means you could secure up to $260,000 if you obtained a home equity loan.

Debt-To-Income Ratio

When deciding whether to provide you with the loan, your lender will calculate your debt-to-income ratio, which shows how your monthly debt payments compare to your monthly income. This calculation helps lenders determine whether you can afford to take on more debt.

To qualify for a home equity loan, your DTI cannot be higher than 45%. To see if you make the cut, you can figure out your DTI yourself, using the following equation:

DTI = Total Monthly Debt Payments  ∕ Gross Monthly Income

  • Add up all your monthly debt payments, including your primary mortgage, student loans, car loan, credit card, alimony, child support, etc.
  • Divide the sum by your gross monthly income, which is the amount of money you earn each month before taxes and deductions.
  • Multiply the result by 100 to find the percentage.

For example, if your total monthly debt is $1,500 (let’s say $950 for your primary mortgage + $300 for your car loan + $250 for your credit card debt), and you earn $5,000 a month before taxes, your DTI would be 30%. In this scenario, your DTI would be low enough to qualify for a home equity loan.

Credit Score

The strength of your credit score also plays a role in determining whether you qualify for a home equity loan. Your credit score is important because it furnishes lenders with a window into your credit history. Individuals with higher credit scores often benefit from lower interest rates.

If you want to obtain a home equity loan, your credit score should be 620 or higher. However, there can be exceptions to this rule.

Home Equity Loans With Bad Credit

Those who have had past credit issues know that it tends to be easier and less costly to obtain a home equity loan than a personal loan. The reason for this is there is less risk involved for lenders because home equity loans are secured by your home. On the other hand, If you’re unable to keep up with your monthly payments, the lender can foreclose on your home to recoup costs.

If you’ve built up a fair amount of equity in your home and have a low debt-to-income ratio, your chances of obtaining a home equity loan will be higher despite a low credit score. If you find yourself in this situation, your home equity loan will likely come with higher interest rates and fees.

If your finances demonstrate to lenders you may be unable to repay the money borrowed, you’ll find it more challenging to obtain a home equity loan. Since the housing crisis, more restrictions have been placed on lending practices. What are the home equity loan rates?

Home equity loan rates are dependent upon the prime rate, credit score, credit limits, lender and loan-to-value (LTV) ratios.

A cash-out refinance is a new first mortgage that allows you to take out in cash some of the equity you’ve built in the home.

You might be able to do a cash-out refinance if you’ve had your mortgage loan long enough that you’ve built equity. But most homeowners find that they’re able to do a cash-out refinance when the value of their home climbs. If you suspect that your home value has risen since you bought your home, you may be able to do a cash-out refinance.

How It Works

When you do a cash-out refinance, you replace your existing mortgage with a new one. The loan amount on the new mortgage is higher than the amount you currently owe. After loan funds are disbursed, you pocket the difference between your new loan amount and your current mortgage loan balance (minus the equity you’re leaving in your home and any closing costs and fees, of course).

Here’s an example: Your home is worth $200,000 and you owe $100,000 on your mortgage. To take cash out, you usually need to leave 20% equity ($40,000) in the home. If you were to refinance your home with a new loan amount of $160,000, you’d get to pocket $60,000, minus closing costs and fees.

Of course, your monthly payments would increase to account for the new loan amount. Estimate your new monthly payments with our refi calculator.

How Much Equity Can You Cash Out Of Your Home?

When you do a cash-out refinance, you usually can’t get a loan for the entire value of the home. Many loan types require that you leave some equity in the home.

To qualify for a cash-out refinance, FHA and conventional loans require that you leave 20% equity in your home. VA loans are an exception, as they allow you to get a cash-out loan for 100% of the value of the home.

Using Your Cash-Out Refi Funds

The cash you get from a cash-out refinance is tax-free and can be used in any way you like. Most homeowners who do a cash-out refinance use the money for renovations, but the money is yours to use however you see fit.

Is a home equity loan the same as a mortgage?

“The process is generally the same between a mortgage and a home equity in that the lender has to evaluate income, employment and appraise the property,” Gupta says. During at least one stage, though, the home equity loan process is faster, Gupta points out.

Should I refinance or take a home equity loan?

You might want to refinance a home equity loan, sometimes called a second mortgage, to save money in the short run with a lower monthly payment. Refinancing could also save you money in the long...

Is a home equity loan better than refinancing?

Typically, home equity loans and lines come with higher interest rates than cash-out refinances. They also tend to have much lower closing costs. So if a new mortgage rate is similar to your current rate, and you don’t want to borrow a lot of extra cash, a home equity loan is probably your best bet.

What are the cons to home equity loans?

What are the cons of home equity loans?

  • Additional costs. Securing a home equity loan isn’t as simple as going to the bank and asking for cash. ...
  • Accrue more debt. In order to take out a home equity loan, equity must actually be therein. ...
  • You can lose your home. As discussed before, it is critically important that one carefully considers the way his or her home equity loan is used.

Is mortgage same as home equity?

Key Takeaways. Mortgages and home equity loans are both loans for which the borrower pledges the property as collateral. One key difference between a home equity loan and a traditional mortgage is that the borrower takes out a home equity loan when they already own or have equity in the property.

Are home equity loan rates higher than mortgage rates?

However, while you'll save money on the closing costs, rates on home equity loans are typically higher than mortgage rates. That's because a home equity loan is typically the second mortgage, and the lender of the first mortgage is first in line to recoup money if your home were to go into foreclosure.

What are the advantages and disadvantages of a home equity loan?

Pros and cons of a home equity loan.
You'll pay a fixed interest rate. ... .
You'll have lower borrowing costs. ... .
Your payments won't change. ... .
You can use the money for virtually any purpose. ... .
Your interest payments may be tax-deductible. ... .
You could pay higher rates than you would for a HELOC. ... .
Your home is used as collateral..

What is difference between mortgage and home loan?

A home loan provides funding to help you upgrade, construct, or buy a residential property. Lenders consider the home or the property as the collateral for the loan. Mortgage loans on the other hand are loans that are taken against a property collateral, i.e. loan against properties.

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