Home Equity versus Conventional Mortgage: Differences You May Notice

There are some important differences between home equity loans and conventional mortgages, primarily in their use. Let’s look at each of these products for comparison.

Home Equity

Home equity loans or mortgages are products that are used by people who already own a home and have been paying their mortgage for some time. The amount of time doesn’t really matter, although the longer you’ve been paying your mortgage the more equity you will have available to borrow. Many people call this type of loan a second mortgage and in some cases, it is just that.

The equity you’ve built in your house is the value of the house on the real estate market minus the amount of money left owing on the principal of your mortgage. The value of your house is not what you paid for it, but what it is worth today. For example, if you have $75,000 owing on the principal of your mortgage and your home is worth $175,000 (if you were to sell it on the market today), then you have acquired $100,000 in home equity.

Most lenders will allow you to borrow up to 75 per cent of the value of your home in a home equity loan. This means that in the scenario stated above you could borrow $75,000 of your home equity. You do not need a down payment to take a home equity loan.

The interest rate on home equity mortgages or loans varies widely, depending on the bank or institution you’re borrowing from. Your home is the collateral for the loan– if you default on your payments the lender can foreclose on your home just like your first mortgage, however your first mortgage (Conventional mortgage) would be paid off first, and then the equity loan. There is basically only one kind of home equity loan – usually a fixed rate loan where your interest rate is determined at the onset of the loan and stays the same throughout the life of the home equity loan.

There are a variety of home equity products to choose from as well, such as a revolving line of credit where you have a “bank account” where you can access funds up to your maximum home equity loan amount, or a ‘cash’ loan, where the funds are released to you.

Home Equity Loan Uses

There are many uses for home equity loans, however the most common uses for the money borrowed from equity are:

• Home improvements – Home improvements top the list. Using the money from a home equity loan to improve the home you live in increases the value of the property, creating even more equity.
• Paying off other debts – Many people use the money from a home equity loan to pay off other debts that have higher interest rates. The interest rates on credit cards are exponentially higher than that of a home equity loan. You can save thousands of dollars in interest payments by using a home equity loan to consolidate other higher interest debts.
• Paying for college – Many parents use the equity in their home to pay for their child’s college education. The interest rate on a home equity loan is much less than student loans or regular loans to pay for college.

Conventional Mortgage

A conventional mortgage is the product that you use to purchase a home. A lender gives you money to buy a home, and you must make a down payment of at least 5%, although 10% is the standard. On a $100,000 home, you’d need between $5,000 and $10,000 cash money for a down payment. There are some laws that that you can not borrow your down payment with a loan. However, the down payment money can be a gift from someone or money that you’ve saved. With the $100,000 home, assuming you’ve put down 10 per cent, your conventional mortgage would be set for $90,000.

It’s important to remember that there will be other fees that you’ll need to pay for with a conventional mortgage as well, such as lawyer’s fees and closing fees with the lender. You’ll get a list of these, called the Good Faith Estimate, as you start the process. Some lenders will even allow you to roll these costs in with the loan. The interest rate will vary on the type of conventional mortgage that you choose from. There are many different types of mortgages such as balloon mortgages and jumbo mortgages; however the two most common types of conventional mortgage are fixed rate and adjustable rate mortgages.

Fixed and adjustable rate mortgages

Fixed rate mortgages are just as they sound – the interest rate is fixed (stays the same) for the entire term of the mortgage while an adjustable rate mortgage, or ARM, has an interest rate that will change at set times during the term.

Many people make the choice between an ARM and a fixed rate mortgage based on the current prime interest rate and the interest rates being offered by the lender. If the current interest rates are high, an adjustable rate mortgage will likely provide relief from those rates in the future when the interest rate is adjusted. However if the interest rates being offered are low, a fixed rate mortgage will lock in that rate to guard a homeowner against rising interest rates.

The product you need

Choosing the product you need is rather simple – but knowing who to go to is crucial. You can use the bank you currently use or a mortgage company or even another lender. A mortgage broker may be useful as well if you’re looking to get the best possible interest rate.

Don’t underestimate the power of the internet when looking for a conventional mortgage or home equity loan. There are many legitimate companies on the internet who have great offers for terms, conditions and interest rates for these two home financial products.