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What is the Difference Between Mortgages and Home Equity Loans?

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  • Written By: John Lister
  • Edited By: Kristen Osborne
  • Last Modified Date: 31 January 2020
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Mortgages and home equity loans are both forms of secured borrowing in which a property acts as security. From a legal standpoint, the difference between the two is very minor, and it is arguable whether it even exists; indeed, a home equity loan is often described as a second mortgage. The main differences between mortgages and home equity loans are practical, such as the rate of interest and the duration of the loan, as well as the order of claim lenders have on the property.

In both cases, the basic concept is the same: the homeowner borrows the money and may forfeit the property to the lender if he does not repay the loan. One technical difference is that it can be argued that with a mortgage, the collateral is the property itself, whereas with a home equity loan, the collateral is the equity. This is the difference between the home's current value and the amount of any outstanding loans; this is effectively the proportion of the property that the homeowner truly owns outright. As the calling in of this collateral will almost always mean the sale of the property, the practical effects of this difference are almost non-existent.

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Because a home equity loan requires the homeowner to have paid off at least some of the property, it will usually only be taken out by somebody who already has a mortgage. This means the home equity lender has a secondary claim on the property; although both the mortgage and home equity lenders have the same right to claim the property in the event of a repayment default, the mortgage lender has priority if both lenders try to exercise this claim. It is possible to have a home equity loan that is the only claim on the home, for example if it is taken out by a homeowner that has already paid off a mortgage in full.

Mortgages and home equity loans differ in two main ways. A home equity loan is usually for smaller amount than a mortgage, borrowed over a short period. The interest rate, then, is usually higher on a home equity loan, often closer to that on a personal loan. The rate on a home equity loan is also usually increased if the lender only has a secondary claim on the property, reflecting the greater risk of the lender not recovering the money.

These two types of loans should not be confused with a home equity line of credit. This is also a form of borrowing where the lender gets a claim on the property as security. Unlike mortgages and home equity loans, however, the lender does not advance a fixed amount of cash. Instead, the lender offers a credit facility, similar to a bank overdraft. The borrower only pays interest based on the time he actually uses the facility.

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