What is the difference between a home loan and a mortgage?
A mortgage is a loan used to buy or refinance a home. If you already own a home and want to get cash out of your equity, you can use a special form of mortgage called cash-out refinancing.
A home equity loan is a little different. Home equity loans are a type of "second mortgage"; H. they are not used to buy or refinance a home. Rather, they are only used to withdraw equity.
Both types of loans are backed by the value of your home. Hence, they offer low interest rates and affordable financing when you need to borrow a large amount of cash.
Which loan is right for you depends on your personal finances and your current mortgage loan. So you decide.
Compare the options for home equity loans and mortgages. Start here (22.09.2021)
In this article (continue to …)
The central theses
There are a few things to consider when deciding between a home equity loan or a mortgage. You should carefully consider your options before deciding on one or the other.
Our best advice runs on:
A mortgage (disbursement refinance) is probably best if you have equity paid out and want to change the interest rate or terms of your current home loan You already have a low interest rate or are about to pay off your home)
If you are unsure which type of mortgage is best for you, check with a mortgage lender. Your loan advisor can help you compare interest rates, loan amounts, and long-term costs to find the best loan for your situation.
Compare the options for home equity loans and mortgages. Start here (22.09.2021)
This is how a withdrawal mortgage works
If you want to get equity out of your home with a mortgage, use a payout refinance.
Cash-out refinancing replaces your existing home loan with a new mortgage. The new loan has a higher balance than your existing one and the difference will be refunded to you as cashback upon completion.
A cash out refinance is a "first lien" or "first mortgage" which means it has slightly less risk than a home equity loan. As a result, the refinancing rates for withdrawals are typically slightly lower than the home loan interest rates.
However, you will have a higher loan amount and higher mortgage payments as you are refinancing the entire loan amount. And you start your repayment term over. That means you may have to pay more interest in the long run than if you had kept your original mortgage.
On the other hand, if your existing mortgage rate is above current market rates, refinancing through disbursement could potentially help lower your interest rate and save some money over the life of the loan.
This is how a home loan works
A home equity loan (HEL) is a type of second mortgage. This means that you leave your original home purchase loan and take out a second, smaller mortgage alongside it. This results in two separate monthly mortgage payments – one for your primary home loan and one for your home loan.
It is likely that these two monthly payments taken together will be higher than what you would pay out if you refinance. So why should anyone opt for a home loan?
Well there are a couple of good reasons. A big problem is that your HEL usually has a shorter repayment period. And that means a shorter period of time to pay interest, which should save you money in the long run.
How a Home Equity Like of Credit (HELOC) works
Home Equity Lines of Credit (HELOCs) are another type of second mortgage that allows you to borrow cash from your home without changing the terms of your first mortgage.
In some ways, HELOCs are more like credit cards than home loans. Because you are given a line of credit that you can borrow, repay, and borrow again. And you only pay interest on your outstanding balance.
And HELOCs differ from HELs in other ways.
Home loans are installment loans, like a mortgage or a car loan. You borrow a lump sum and pay it back in equal installments over the fixed term of the loan, usually at a fixed interest rate. So they are predictable and easy to budget for.
However, with HELOCs, you usually get a loan in two parts.
During your "drawing period" (often 10 years, but sometimes also five or 15 years) you only pay interest on your current balance, usually at a variable interest rate. During this time, you will no longer be able to borrow, but you will need to pay off your debt to zero before this deadline while maintaining interest payments
HELOCs can be great for people whose income fluctuates a lot, such as: B. Contractors, freelancers and seasonal workers. But they are dangerous to those who are bad money managers. If you have a tendency to maximize your credit cards, you can do the same with a HELOC.
Find the right disbursement loan (09/22/2021)
Home Loans vs. Mortgage Refinancing: Pros and Cons
So what are the pros and cons of a home loan versus a mortgage? Here is a brief overview:
Home loanMortgage (Cash-Out Refinancing)interest chargesHigher ratesLower ratesCredit terms10, 15 or 20 years, 30 or 15 years max. loan amountUp to 85% of the home value Up to 80 percent of the home valueClosing costs2-5% of the equity borrowed 2-5% of the total mortgage
Now let's look at their main features side by side.
The interest rates on home equity loans are usually slightly higher than those on cash-out refinancing. There is a technical reason for this. HELs are “second liens”. And that means they are riskier for mortgage lenders because they would be paid second in the event of foreclosure.
However, the price differences are usually small. And the loan amount on a home loan is smaller than that on a mortgage refinance – so you pay interest on a smaller amount.
In addition, both HELs and cash-out refinances are fixed-rate loans. This makes your interest and loan payments predictable.
Regardless of which type of loan you choose, you should look around for the best interest rate on your loan. Compare personalized rate quotes from at least 3 lenders to find the best deal.
The closing costs for cash-out refinancing and home loan are about the same percentage: often 2-5% of the mortgage lending value. But of course your loan amount is smaller with a HEL. So the total upfront fees are much lower.
Both types of loans can last up to 30 years. But home equity loans rarely do. More often they have terms of five, 10, 15 or 20 years. If, on the other hand, you want mortgage refinancing, your new loan will usually last 30 years.
Terms of 10-25 years are also available for cash-out refinancing. However, short term loans have much higher monthly payments because you pay back the same loan amount in a shorter period of time. And that's a deal breaker for many borrowers, especially those who already have a high debt-to-income ratio (DTI) or low monthly cash flow.
Cash-out refinancing on a new 30-year mortgage can also pose problems.
For example, if you've already paid off your existing 30-year loan for 10 years and are refinancing into a new 30-year loan, you will be paying for your home over 40 instead of 30 years. Worse still, you I will pay interest on a large sum for 40 years instead of 30 years. And that's expensive, even with lower interest rates.
So there is a huge benefit to taking out a 10 or 15 year home loan. You're still paying off your home for over 30 years. And you are more likely to pay less overall interest on both loans, despite the different interest rates.
Amount of equity that you can withdraw
How much money you can withdraw from your home depends on your current loan balance and the value of your home.
Typically, when you get a cash out refinance, you need to leave at least 20 percent of the value of your home untouched. That means your new loan can only be up to 80 percent of the value of your home (known as the 80% mortgage lending ratio).
The loan must also pay off your existing mortgage. So your maximum cashback is 80 percent of the value of your home minus your current loan balance.
The market value of your home is $ 400,000. Your current mortgage balance is $ 200,000. Loan payout amount is $ 320,000 (80% x $ 400,000)Your maximum cashback is 120,000 ($ 320,000 – $ 200,000)
Only VA loans (Mortgages for Veterans and Service Members) allow you a cash-out refinance where you withdraw 100% of your equity.
The calculation is similar for home equity loans.
You are not using the new loan to pay off your existing one. But the first mortgage and the second mortgage combined must generally not be more than 80 percent of the value of the home. So the math works the same way.
However, some home loan lenders are more flexible and allow you to borrow up to 85 percent of the value of your home.
This is how you can use the funds
Neither cash out refinances nor home equity loans dictate how you can use the funds. It's entirely up to you.
Typically, however, you want to use the money for something with a good return. That is because you are paying interest on the cash and it is backed by your home.
Popular uses for home equity are home renovations and debt consolidation (using the money to pay down high interest personal or credit card debt).
Possible tax advantages of a cash-out refinancing
According to CNBC, cash-out refinancing loans can be tax deductible for eligible borrowers:
"Homeowners may also be able to deduct interest on the first $ 750,000 on the new mortgage if the cash is used for capital improvements (although most households now do not benefit from this write-off)."
Well, we are not tax consultants. So you need to seek advice from a professional yourself before relying on this information.
But you may be able to set off money for home improvement. So see if that's why you want to borrow. Because it could be a determining factor in your personal home equity vs. mortgage analysis.
Faster money when you need to cover pandemic costs
Incidentally, the federal regulator, the Consumer Financial Protection Bureau, accelerated access to funds through payout refinancing and HELs last year when you urgently need cash to cover pandemic-related expenses. If this applies to you, read this article.
When should a mortgage be used over a home loan
Choosing a payoff refinance over a home loan can be a great way to keep your monthly expenses down. Remember, payments are usually cheaper because you are only paying one mortgage, not two.
Cash-out refinancing is also a better option if you need to refinance anyway. Say your current mortgage rate is 4%, but you could refinance to 3%. You would cut your monthly payments. And your savings would soon pay for your shutdown costs.
Of course, if you withdraw a lot of money with your refinancing, you can still get a higher monthly payment. But you will also have this flat rate. And you can do whatever you want with the funds, just like you would with a home equity loan.
When Should One Use a Home Loan Instead of a Mortgage?
If your current mortgage is almost paid off or you already have an extremely low mortgage rate, a home loan is usually a better choice than cash-out refinancing.
By choosing a HEL, you can use your equity without extending the term or changing the interest rate on your current loan.
You can also opt for a home loan if you can afford a higher monthly payment and want to save more in the long run. Keep in mind that a HEL will likely cost more month to month – but you will pay it off much sooner than a payoff mortgage.
You also save closing costs. And while the interest rate you pay may be higher, the fact that you borrow less for a shorter period usually means you will be better off in the long run.
You can use our refinance calculator to work out your numbers.
Is A Home Loan Possible Without A Mortgage?
Yes. If you've already paid off your mortgage or bought the house with cash, you can still get a home loan. Or a new mortgage. Provided you can afford the monthly payments and have good (or better) credit, it should be very easy for you to qualify.
You may even be able to borrow up to 80% or 85% of the value of your home in cash. But if you want that much, you will likely prefer the mortgage route. And you will certainly want to think carefully about taking on that much debt.
Home Loan vs. Mortgage: The Bottom Line
Chances are that for many readers that debate ended when they learned that cash-out refinancing would almost certainly be less costly in the short term. Many of us, especially when we are younger, have no choice but to focus on minimizing our current expenses and letting the future take care of itself.
But those who can afford to take a strategic look at their finances may well find that a home equity loan will save you money in the long run. And that's really what matters to them.
Confirm your new plan (September 22, 2021)