While mortgages are typically lending tools that allow you to purchase and finance your home, home equity loans can be taken out later in the process – after the homeowner has already accumulated equity in a property.
Both are installment loans that are repaid over a fixed term, and both use your property as collateral.
You may be considering consulting with a lender like AMF Equity Loans in BC, but how do mortgages and home equity loans work, and what are the main differences?
How Mortgages Work
A mortgage is a loan that helps you finance your home. The most common type of mortgage is a 30-year fixed-rate loan; however, there are other options. Other mortgage options include 15-year-fixed-rate loans and adjustable-rate mortgages.
To qualify for a mortgage, lenders have a strict set of criteria that you have to meet.
These requirements include a minimum credit score that indicates a responsible repayment history, a good debt-to-income ratio that proves that you earn enough money to cover other expenses like credit cards and loans, and enough cash to cover your closing costs on the mortgage you are applying for.
How a Home Equity Loan Works
While mortgages are an option before you even purchase your house, home equity loans become available later on.
Whether you are still paying off your mortgage or have paid it in full, a home equity loan is a way to use the equity of your home to take out another loan – so it’s like a second mortgage.
For instance, if your home is worth $300,000 and you still owe $125,000 on your original mortgage, you have $175,000 of equity in your home. You can use this equity (what you’ve already paid off) as collateral for a loan.
Depending on your credit profile and the lender you’re working with, you can borrow up to 85% of your equity. Bear in mind that this figure will also depend on other factors, such as if the home is an investment property and if you are applying with a co-borrower.
What are the Differences?
With both equity loans and mortgages, you are taking out a loan and you need to commit to repaying it. If you lapse on your payments, the lender can take your collateral. This is called foreclosure, and it means that the lender can take your home.
While equity loans and mortgages are both loans on collateral, there are two major differences.
1. Equity Loans Apply When You Already Have a Home
The key difference between equity loans and mortgages is that the borrower may take out an equity loan when they already own or are paying off the property.
2. The Amount You Can Borrow Varies
Lenders will generally allow homeowners to mortgage up to 80% of their equity, while the percentage you can borrow with a home equity loan depends on how much of the property you already own (the percentage you have already paid off on your mortgage). The rates on home equity loans are also typically higher than the rates of a mortgage, however, with a home equity loan, you can save on closing costs.
