Home equity loans are debt products that cater to current and prospective homeowners. But maybe you aren’t entirely clear about the key differences between the two options.
In this guide, you’ll learn how home equity loans and mortgages work and how to use each option. You’ll also discover a viable alternative to access home equity without borrowing from the bank, credit union or another financial institution.
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Home Equity Loan vs. Mortgage: What Is The Difference?
There are distinct differences between home equity loans and mortgages.
What Is a Mortgage?
A mortgage is a loan product you can use to buy a new home. You can also use it to refinance your existing home to get a lower interest rate and more affordable monthly payment.
Suppose you have a sizable amount of equity in your home. In that case, you may qualify for a cash-out refinance, which is a mortgage product that lets you convert a portion of your equity into cash.
What Is a Home Equity Loan?
A home equity loan acts as a second mortgage. It lets you borrow against the equity in your home and is also available to borrowers with a decent sum of equity built up.
How Does a Mortgage Work?
As mentioned earlier, you can use a cash-out refinance to pull equity from your home. Most lenders let you borrow up to 80 percent of your equity, and you’ll receive cash at closing.
Here’s an example of how it works:
- Assume your home is worth $425,000, and you owe $255,000 on your mortgage.
- If the lender approves you for a cash-out refinance, you could pull out up to $85,00 in cash. The lender will also pay off your old mortgage at closing.
- You’ll get a new loan for $340,000 ($255,000 + $85,000).
When it’s time to resume payments, you’ll make your mortgage payments with the new lender for the duration of the new loan term.
How Does a Home Equity Loan Work?
A home equity loan acts as a second mortgage and lets you convert your equity to cash. But you won’t have to refinance your existing mortgage. Instead, you’ll get a lump sum, typically capped at 85 percent of your home’s equity, that’s repayable in equal monthly installments over a 20- to 30- year period.
To illustrate, if your outstanding mortgage balance is $265,000 and your home is worth $475,000, you could get a home equity loan of up to $138,750 ($475,000 * .85 – $265,000).
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When To Use a Mortgage vs. a Home Equity Loan
It’s more sensible to use a cash-out refinance mortgage if:
- You qualify for a lower interest rate.
- You still have several years remaining in your loan term.
- You’d prefer to make a single monthly payment instead of two.
- You can afford a higher monthly mortgage payment.
When To Use a Home Equity Loan vs. a Mortgage
However, a home equity loan is likely the better choice if:
- You already have a competitive interest rate.
- You’re nearing the end of your loan term.
- You’d prefer to keep your monthly mortgage payment low.
- You want to keep closing costs to a minimum.
Other Ways to Access Home Equity
Beyond cash-out refinances and home equity loans, there are other ways to tap into your equity.
Unison HomeOwner
Unison, a Better Business Bureau, A+ rated home investor, lets you tap into your home equity without taking out a loan that requires monthly principal and interest payments. Plus, there are no restrictions on how you can use the funds you receive, and you remain the sole owner of your home throughout the agreement.
This option is called Unison HomeOwner, and you can swap up to 17.5 percent of your home’s value for a co-investment. You’ll have 30 years to decide if you want to sell your home or stay in your home and buy out the agreement.
Co-investments between $30,000 and $500,000 are available to homeowners with credit scores of 620 or higher. Your LTV also shouldn’t be higher than 75 percent.
Home Equity Line of Credit (HELOC)
A HELOC is a revolving line of credit that you can borrow whenever you need money and make payments to increase the available funds. Most HELOCs are capped at 85 percent of your home equity, and you’ll get a draw period of up to 10 years.
You’ll only pay interest on the amount you borrow during the draw period. Once the draw period ends, borrowing is no longer allowed. The outstanding balance will be repayable in monthly installments over a set period of up to 20 years. But be mindful that the monthly payment can fluctuate since most HELOCs come with a variable interest rate.
Home Equity Loan vs. Mortgage: The Bottom Line
Ultimately, deciding between a home equity loan and a mortgage comes down to your financial situation and which works best for you. But if you’d prefer not to take out a loan to access the equity in your home, consider a co-investment from Unison HomeOwner to meet your needs.
Use Unison’s calculator today to see how much equity you can unlock from your home.
