What is the difference between a home mortgage and home equity loan?
Let’s play a game, shall me? After reading the following words, what reactions come to mind? Mortgage. Loan. Home insurance. Banks. The associations are enough to give any sane human a heart attack, or at a minimum, a splitting headache. I include myself in that number, and am therefore on a one-woman mission to demystify the home buying process. Today we are going to hit upon some pretty significant basics. What is the difference between a home mortgage and home equity loan?
Home Mortgage 101
Let’s start with the basics. A home mortgage is the loan you take out from a bank in order to afford the full cost of a house. In a way, both you and the bank are one another’s employer (yes, employer). After the bank analyzes your employment history, income and credit history, they offer you a specific interest rate for the loan based on their perception of your financial trustworthiness. Whether you consider the rate good, fair or bad, it is within your power to present the same documentation to an alternative mortgage company to see if they will offer you a lower rate. No, this is not refinancing, which hinges on you owning a home in the first place. This is old-fashion shopping around in an effort to see which mortgage company deserves you. Contrary to common belief, you will not be locked into working with a specific lender until you have made a bid for a specific house, and are preparing to sign the final dotted line.
Your Home Mortgage: A Source of Joy . . . And Fear
Your dream home, and even "dream" mortgage, comes with strings attached. Traditional mortgages schedule payments over the course of 15 and 30-year fixed increments. Other terms are available, but they generally involve greater risks. You can “double up” payments, and pay your 30-year mortgage in 15 years, or even less. But there are consequences for failing to meet a minimum monthly payment. If you stop paying off your loan, the bank can claim your home as a form of collateral. At that point, you will have the option of borrowing against the percentage of the house you already own through your down payment and the number of payments you have already made. This is better than immediately losing one’s house, but when it occurs, paying the bank must become one’s #1 financial priority. Borrowing against the percentage of home you already own can turn sour very quickly.
Home Equity 101
Home equity is the gap between how much you owe on the mortgage and the present value of the house. For example, if your neighborhood, “goes downhill” because the local school repeatedly has low test scores, the equity of your home will decrease. On the flip side, if two large corporations move within a few miles of your home, and a number of freshly-relocated employees are willing to pay premium for houses in your neighborhood, your home equity will increase, even though you have made no actual improvements to your house. Another determining factor of your home equity is the amount you pay in your down payment. For example, if you purchase a $270,000 with a down payment of $30,000, your house has a home equity value of $30,000 from day one.
A home equity loan is what you take out when you borrow money against the house payments you have already made and the current value of your home. It functions as a second mortgage, and is typically paid out between 5-30 years. Home equity loans generally have higher rates than fixed rate mortgages, and do not provide a variable rate option.
In other words, home equity loans should never be a homeowner's first, second, or even third resort for balancing out their finances. But when trouble strikes, the option is there
If you're on a mission to master the mortgage process and secure your dream home, remember that you're not alone. This is not sacred knowledge, and you do not need an MBA to conquer your dream of home-ownership. Questions you pose or answer today could help another dreamer just like you in the future. Together, we can do this RIGHT!
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