The question of whether a home equity loan or a mortgage is best for you is hugely important. When you’re considering taking out a loan, it’s important to understand all of your options and which product will best meet your needs. There are many different types of loans available, and each one has its own benefits and drawbacks.
In this article, we will undertake a detailed comparison of home equity loans and mortgages. We will explain the differences between these two types of loans, and we will help you decide which one is right for you.
How does a home equity loan work?
A home equity loan, also known as a secured loan is a type of loan that allows you to borrow money against the value of your home, or an investment property. To get a home equity loan, you will need to have equity in your property. Equity is the portion of your home’s value that you own outright without any debt attached to it.
For example, if your home is worth £200,000 and you owe £100,000 on your mortgage, then you have £100,000 in equity. You can use this equity to get a loan, and the amount that you can borrow will depend on your chosen lender and the value of your home.
How do mortgages work?
A mortgage loan is a type of loan that you can use to finance the purchase of a property. When you get a mortgage loan, you will borrow money from a lender, and they take a legal charge over the property, which gives them certain rights as the property has been used as collateral for the loan.
Mortgage lenders take a first charge over your property, whereas secured loan lenders take a second charge. This means that the mortgage lenders are in a more secure position, and therefore usually charge lower rates as a result.
What is the interest rate difference between a home equity loan and a mortgage loan?
The interest rate on a mortgage loan is usually lower than the interest rate on a home equity loan. This is because, from a lender’s perspective, mortgages are considered to be less risky than home equity loans since they are secured by a first charge, rather than a second charge.
However, the interest rate on both types of loans can vary depending on your chosen lender, your personal circumstances and the loan to value required.
On average, a rate difference between 1-2% per year is common between a mortgage and a secured loan. That said, there are circumstances where a home equity loan can work out cheaper, such as when there are early repayment charges on your current mortgage, increasing the cost of switching lenders.
What is the closing costs difference between a home equity loan and a mortgage loan?
When you take out a loan, you will be responsible for paying certain set-up costs. In the UK, these are usually referred to as set-up fees, while in the US and Australia, they’re usually called ‘closing costs’. Whatever you choose to call them, they are fees charged by the lender to process your loan.
The closing costs can vary depending on the type of loan that you take out. However, they are typically higher for a home equity loan than they are for a mortgage loan. The biggest difference in cost comes from the increased broker fees that are charged by many secured loan brokers, with the broker fees for mortgages usually being much lower.
On top of the broker fees charged, the other main setup costs are lender arrangement fees, valuation fees and legal costs.
What are the factors to consider in choosing the right loan?
There are a few factors to consider when choosing the right loan.
- Does the product fit well with your financial goals – Borrowing isn’t something that comes down solely to price. For example, if you’re looking for a product that will have fixed payments for a set period of time, then selecting a variable rate loan is risky.
- Interest Rate – A big factor is the interest rate. You will want to compare the interest rates of different loans to find the right one for you. This is because the interest rate will determine how much you will have to pay back in total.
- Loan Term & Payment Flexibility – The next factor is the term of the loan. The term is how long you have to repay the loan, and it can vary from a few years to several decades. You will want to choose a loan with a term that you are comfortable with and that fits your needs.
- Your Credit Score – Your credit score is a number that represents your creditworthiness. Lenders use it to determine whether or not you are a good candidate for a loan. If you have a high credit score, you will have a greater selection of products and may be able to get a better deal.
- Set-up Costs – Set-up costs are the fees that you will have to pay to get the loan. They can include valuation fees, lender arrangement fees, broker fees and other miscellaneous charges. Be sure to ask about the closing costs when you compare loans so that you can budget accordingly.
- How quickly you need the funds – The sixth and final factor to consider is the provider’s response time and support. You will want to make sure that you are working with a loan provider who is able to offer the funds you need in a timescale that suits you. Some providers can complete loans within a couple of weeks, whereas others can take much longer.
When it comes down to it, there are a few key factors to consider when choosing the right loan. Be sure to compare interest rates, loan terms, and closing costs before deciding. And most importantly, make sure that you are working with a reputable and responsive loan provider.
The best way to approach this is to talk to various loan providers and compare their offers. This way, you can be sure that you are getting the best deal for you. And remember, the lowest interest rate isn’t always the best deal if it comes with higher fees. Take your time and make sure you understand all the terms and conditions of the loan before you commit to a product.
When should you choose a mortgage over a home equity loan?
There are a few situations when it might be better to choose a mortgage over a home equity loan might be better. If you need a large amount of money – If you need to borrow a large sum of money, then a mortgage is likely going to be your best option. This is because home equity loans typically have lower borrowing limits than mortgages.
If you want the lowest interest rate possible – Mortgage rates tend to be lower than home equity loan rates. So if you’re looking for the lowest interest rate possible, then a mortgage is probably your best bet. That said, the total cost of borrowing should be considered including any early settlement fees on your current mortgage as this can significantly impact the overall cost.
Finally, if you’d like to keep your borrowing under one monthly payment and one facility, then borrowing through a mortgage allows you to do just that. While there’s no real advantage to doing this, many people find it easier to manage their finances when there are fewer payments to make each month.
Of course, these are just a few general guidelines. The best way to decide if a mortgage or home equity loan is right for you is to speak with a financial advisor or secured loan broker. They can help you figure out which option is best based on your individual circumstances.
Can a home equity loan replace a mortgage loan?
Yes, a home equity loan can replace a mortgage loan. They are a viable alternative for homeowners who are looking to raise money. It would be more accurate to say that a home equity loan is an alternative to a remortgage.
This is especially true for borrowers who either have early repayment charges on their current mortgage, or those who have an excellent deal and don’t wish to give it up. As both products essentially serve the same purpose, they can be seen as a true replacement of one another.