Home Equity Loan vs Mortgage: What You Need To Know

A home equity loan is used for various projects, such as consolidating debts, making home improvements, or covering other expenses. On the other hand, a primary mortgage is used to buy a home. Here are the similarities and differences between a home equity loan and a mortgage, along with RenoFi loans as an alternative if you are looking for more cash to take on major home renovations or additions. 

Understanding a Mortgage Loan 

A mortgage is a loan type specifically used to finance the purchase of a home. You borrow money from the lender to buy a property. In turn, you agree to pay the loan back over a set period—usually 15 to 30 years. A mortgage allows you to purchase a home without having to pay the full price upfront, spreading the costs out over time and making payments manageable. 

How Mortgages Function 

Once approved for a mortgage, you sign a contract with the lender, which outlines the repayment terms, including the interest rate, loan amount, and repayment schedule. Your mortgage will specify whether the loan is fixed-rate, where the interest rate remains the same, or variable-rate, where it fluctuates over time. The lender provides the funds, allowing you to take ownership of the home, while retaining a legal claim over the property (known as a mortgage lien) until the loan is fully paid off.

As you make payments, you gradually build equity in your home—the portion of the property that you actually own. However, the lender holds a claim to the home as collateral. If you fail to keep up with payments, the lender has the legal right to repossess the property through foreclosure and sell it to recover the remaining debt.

What Happens After the Loan Closes?

Once your mortgage closes, you officially own the home, but the lender still holds a claim to it until you’ve paid off the debt. As you make monthly payments, part of your payment goes toward reducing the principal loan balance while another portion covers interest. This process allows you to build equity in your home over time.

If you decide to sell the property before fully paying off the loan, you must use the proceeds from the sale to pay off any remaining mortgage balance. If the sale amount exceeds this balance, you’ll keep the difference.

Additionally, if the property value increases over time, you may have the opportunity to refinance your mortgage. Refinancing lets you secure a lower interest rate or adjust your repayment terms to better suit your financial situation.

Types of Mortgages

There are several types of mortgages available, each designed to meet different financial needs:

• Fixed-Rate Mortgages: These loans have an interest rate that remains constant throughout the life of the loan, providing predictable monthly payments.
• Adjustable-Rate Mortgages (ARMs): These loans have interest rates that can change at specified intervals based on market conditions, which can lead to lower initial payments but potential increases over time.
• FHA Loans: These loans are insured by the Federal Housing Administration and are designed for low-to-moderate-income borrowers. They usually require lower down payments.
• Conventional Loans: These are not insured or guaranteed by the government and usually require a larger down payment.
• USDA Loans: These loans are aimed at rural homebuyers and are backed by the U.S. Department of Agriculture. In addition to low-interest rates, they offer no down payment options.
• VA Loans: Available to veterans and active-duty military members, these loans are backed by the Department of Veterans Affairs and often require no down payment.

Mortgage Requirements 

The following are a few requirements that must be met in order to obtain a mortgage:

• Must have a minimum proposed credit score. The minimum typically depends on the type of loan you are seeking. 
• A minimum down payment for the mortgage 
• Enough available funds to pay closing costs
• A good debt-to-income ratio 

Understanding a Home Equity Loan 

Home equity loans are secondary mortgages that enable you to access more financing for major home renovations and even outstanding debts. You receive a lump sum payment from the lender and then pay it back in fixed monthly payments (usually 5 to 15 years). It is very similar to a mortgage.

These loans often have a fixed interest rate, meaning that your monthly payments will typically stay consistent throughout the loan’s life. 

A home equity loan may even be tax-deductible in some cases, but only if it is used to buy, build, or substantially improve the home. 

How Home Equity Loans Function 

A home equity loan gives you access to as much as 80% of the total home value. However, some lenders limit borrowing in specific circumstances. To calculate your home equity, take your current home value and subtract your remaining mortgage balance. For example, if your home is currently worth $300,000 and you still owe $200,000, then your equity is sitting at $100,000.

Similarities Between Mortgage and Home Equity Loans 

• These loans are secured by the property
• Both loans give you access to relatively large financing amounts
• These loans tend to have lower interest charges compared to other loan types
• Both require qualification standards, such as a minimum credit rating and debt-to-income ratio
• The application process is similar. You will need to provide income documentation, and there is a credit check. The lender may also require an appraisal to determine the home’s current value and they will also take a closer look at your debt-to-income ratio. 

Differences Between Home Equity Loans and Mortgages 

• A mortgage is used to purchase a home or property while a home equity loan is used to borrow against the equity you have in the home and is considered a secondary loan.
• Mortgages can have either fixed or adjustable interest rates. A fixed-rate mortgage means consistent payments, while an adjustable-rate mortgage can fluctuate.
• The repayment terms are also different. A mortgage usually has a longer repayment period, while a home equity loan is often much shorter. 
• When the funds are disbursed for a mortgage, they go directly toward the purchase of the home. The funds from a home equity loan, on the other hand, are given in a lump sum and can be used for any purpose.

When to Choose a Home Equity Loan 

A home equity loan is a good option in specific circumstances that require you to access a lump sum of money, and you have a significant amount of equity built up in your existing home. It can also be used for covering large expenses like medical bills, college tuition, wedding costs, and more. 

Benefits of RenoFi Loans: Your Financing Alternative

As traditional loans offer 90% LTV on HELOC, the plan doesn’t usually cater to all the renovation projects you may have on your list. RenoFi loans calculate the after-renovation value of your property to increase your equity. 

Here’s a couple examples to demonstrate how you can borrow more money with RenoFi assuming  you want to spend $150,000 to renovate your new home and increase the value of your home by $150,000:

Scenario 1 (New Home Purchase): 

• Home price: $600,000
• Downpayment (20%): $120,000
• Current Mortgage Amount: $480,000

Example Home Equity Loan Amount: 

• $600,000 * 80% = $480,000 (80% of Total Home Value)
• $480,000 - $480,000 (Current Mortgage Balance) = $0 (Home Equity Loan Amount)

Example RenoFi Home Equity Loan Amount:

• Assuming that your renovation project will add $150,000 to your home value

• After Renovation Value of Your Home: $750,000

• RenoFi Loan Amount: 

  • $750,000 * 90% = $675,000 (90% of Total Home Value)
  • $675,000 - $480,000 = $195,000 (RenoFi Home Equity Loan Amount)

Using a RenoFi Home Equity Loan you have increased your loan amount from $0 to $195,000. Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $195,000 because the RenoFi loan is written against your ARV (After Renovation Value).

Without RenoFi loans, you would not have been able to borrow the $150,000 needed to add the renovations that would increase the value of your home by $150,000. Now, with RenoFi loans, you are now able to get the loan you need to add the renovations you want to your home.

Scenario 2 (Recent Home Purchase): Assuming that you have now paid 10% of your mortgage:

• Home price: $600,000
• Current Mortgage Amount: $420,000

Example Home Equity Loan Amount: 

• Example Home Equity Loan % of Home Price: 80%

• Example Home Equity Loan Amount: 

  • $600,000 * 80% = $480,000 (80% of Total Home Value)
  • $480,000 - $420,000 (Current Mortgage Balance) = $60,000 (Home Equity Loan Amount)

Example RenoFi Home Equity Loan Amount:

• Assuming that your renovation project will add $150,000 to your home value

• After Renovation Value of Your Home: $750,000

• RenoFi Loan Amount: 

  • $750,000 * 90% = $675,000 (90% of Total Home Value)
  • $675,000 - $420,000 = $255,000 (RenoFi Home Equity Loan Amount)

Using a RenoFi Home Equity Loan you have increased your loan amount from $60,000 to $255,000 (4.25x more). Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $255,000 because the RenoFi loan is written against your ARV (After Renovation Value). 

Here’s a summary of the difference between traditional and RenoFi home loans in table form: 

In addition to letting you borrow more money for your home renovations, RenoFi loans also offer:

• No draw periods
• No inspections
• No need to give up your original loan
• Higher borrowing limits

RenoFi loans are funded on the day the loan is closed and that is it. Take out the $195k and you get $195k in your bank and you have 20 years to pay off in equal monthly payments with interest and principal, just like a standard mortgage.

Conclusion  

Home equity loans and mortgages offer many similarities and benefits, allowing you to access more funding for your home purchases and renovations. RenoFi loans, however, are an ideal way of financing any large renovation project you may have in mind. While conventional loans depend on the current value of your home, RenoFi loans work on the after-renovation value, which enables you to access, on average, 11 times more. You also get minimum monthly payments and lower rates on your primary mortgage. Get funding for your property renovation today with RenoFi loans.  

Explore your RenoFi loan options here.