Home Equity Loans vs Home Mortgages: What’s Best for You?


Home Equity Loans vs Home Mortgages: What’s Best for You?


When tapping into the value of your home, there are two major routes to consider: taking out a mortgage or using home equity. Both options can support major life goals like home improvements, debt consolidation, or securing long-term stability; but they operate differently, and the right choice depends on your financial situation.

 

Key Takeaways:

  • A mortgage is ideal when buying or refinancing a home, offering fixed or adjustable interest rates and structured monthly payments.

  • A home equity loan uses the equity in your home as collateral and typically offers a fixed interest rate with lump-sum disbursement.

  • Closing costs, loan terms, and payment structures vary between options and lenders.

  • Your credit score, income, and debt-to-income ratio all play roles in credit approval.

  • The best choice depends on your current needs and long-term goals.

 

Understanding Mortgage Loans

A mortgage loan is the most common type of financing when purchasing a home. This loan is secured by the home itself, and the loan amount is typically repaid over a long term; 15 to 30 years is common. Your interest rate may be fixed or adjustable, depending on the lender and the program guidelines.

A fixed rate mortgage offers predictable monthly payments, making it easier to budget over time. Alternatively, an adjustable rate mortgage starts with a lower initial rate but may increase after a set period. Either option involves closing costs, a down payment, and a loan application process that includes a credit report review and verification of income.

Choosing a mortgage is typically the best route when buying a new home or refinancing your current mortgage for a lower mortgage rate or more favorable loan terms.

 

How Home Equity Loans Work

A home equity loan allows homeowners to borrow money against the equity in your home. That is, the difference between your home's current value and the balance of your mortgage. These are sometimes referred to as second mortgages and are often used for home improvements, education expenses, or consolidating debt.

Unlike a home equity line of credit (HELOC), which functions as a revolving line you can draw from during a draw period, a home equity loan provides a one-time lump sum with a fixed interest rate. Your monthly payment remains the same for the life of the loan, which can make budgeting simpler. However, closing costs, origination fees, and application fees may still apply, depending on the lender.

When considering this type of financing, ask your lender: How much home equity do I need to qualify? Most lenders require at least 15–20% equity, and approval may also hinge on your credit history, credit score, and debt to income ratio.

 

Choosing Between the Two

When it comes to deciding between a mortgage and a home equity loan, consider:

  • Loan purpose: A new home requires a mortgage. For renovations or major one-time expenses, a home equity loan may suffice.

  • Loan amount: Mortgages usually allow for larger loan amounts. Equity loans are smaller but faster to secure.

  • Interest rates: Mortgages tend to offer lower interest rates since they’re the primary lien.

  • Repayment terms: Mortgages offer longer term lengths and potentially lower monthly payments; equity loans are shorter with quicker payoff.

  • Tax implications: According to the IRS, interest paid on a home equity loan may be tax deductible if the funds are used to improve the home. Always consult a tax advisor.

 

Factors That Impact Loan Approval

No matter which path you choose, your financial situation plays a role. Most lenders evaluate:

  • Your credit score and credit report

  • Debt to income ratio and overall creditworthiness

  • The combined loan to value (CLTV) ratio of your home

  • Whether you have enough equity built up

  • Your history of automatic payments and banking habits, including use of a savings account or online banking

Some borrowers also consider government-backed options like VA loans, especially when they offer favorable loan terms and reduced closing costs for qualified applicants.

 

When to Consider Debt Consolidation

If you're carrying multiple high-interest loans or credit card balances, using a home equity loan to consolidate debt can be a cost-effective solution. By combining debts into one monthly payment with a fixed annual percentage rate, you simplify finances and potentially save money over time, especially if you secure a lower loan’s interest rate compared to other loans.

However, this strategy isn't for everyone. Always weigh the total cost of the loan—including fees, interest rates, and other factors—and ensure you can manage the new monthly payments comfortably.

 

Let’s Help You Find the Right Loan

Whether you're looking at home equity loans to fund a project or navigating the process of choosing a mortgage, Farmers Bank is here to guide you every step of the way. Our team will help you understand your options, explain the application process, and work toward loan terms that align with your goals.

 

FAQs

Is a home equity loan the same as a home equity line of credit?
No. A home equity loan provides a lump sum with a fixed rate, while a home equity line allows for multiple withdrawals and may have a variable interest rate.

Can I have a mortgage and a home equity loan at the same time?
Yes. This is common. You must have enough equity in your home and meet the lender’s credit approval requirements.

Are closing costs required for home equity loans?
Most lenders do charge closing costs, though some may waive them. Always ask for a loan estimate upfront.

Do I need a great credit score to get approved?
While a higher credit score improves your chances, some loan programs may work with lower scores, especially if you have strong income and home equity.

Is the interest on home equity loans tax deductible?
Sometimes. If the funds are used for home renovations or home improvements, the interest rate may qualify. Always check with your tax advisor.

Can a financial advisor help me choose the right mortgage?
Yes. A financial advisor can offer insight into how each loan affects your overall budget and long-term financial goals.