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Published by Contour Mortgage on May 07 2021

How Does a Home Equity Loan Differ From a Mortgage?

Topics: Home Buyers, first time home buyers, Home Equity

Whether you’re a first-time buyer or want to utilize your home’s equity for improvements and upgrades, choosing the best loan type is dependent on several factors. 

When it comes to a traditional mortgage loan, there are various options offered by reputable lenders, such as Contour Mortgage. These are built on requirements including income, credit scores, down payment amounts, loan limits, and other stipulations. 

 Home equity loans, however, differ for their uses and advantages. Most homeowners lean toward these to tap into accrued capital for updates and improvements, or other expenses, such as education, secondary homes, investment properties, or debt consolidation. 

 Below we’ll discuss both of these loans’ requirements, benefits, uses, terms, and more.


Traditional Mortgage vs. Home Equity Loan

As aforementioned, both home equity and traditional mortgage loans are utilized for financing purposes. The difference between the two is their intent, requirements, repayment options, and benefits. 

Traditional Mortgage

Borrowers purchasing a new home usually opt for a traditional mortgage. A lender such as Contour Mortgage can provide this upon successful pre-approval and loan commitment. Mortgages hold the home as collateral with good faith the borrower will repay what’s owed within a specified time frame, with interest. 

Dependent on terms and requirements, most lenders offer fixed- or adjustable-rate mortgages (ARM) for repayment within 15 or 30 years. Choosing the best relies on factors such as debt-to-income ratios, loan-to-value ratings, credit scores, down payment amounts, and other requirements. 

While there are several conventional and government-backed loans  offered through Contour Mortgage, it can be challenging to identify which is the right fit. It’s best to work with a representative to help you navigate this process. 

 

Home Equity Loan

A home equity loan can be utilized by borrowers who have accrued equity through timely principal-based mortgage payments and other increases. Equity is the difference between your home’s market value and what the borrower still owes. This can work in your favor, especially if you’ve purchased a home that has recently increased in value due to current market conditions. 

These loans are mainly geared to increase your home’s worth through improvements such as additions, renovations, and other cosmetic upgrades. 

Some homeowners might also borrow against their home’s equity to finance good debt, such as a child’s education, investments, or a secondary or vacation home. While home equity is ideal for purchases benefiting your home and family, it should not be used toward depreciating items, such as vacations, luxury cars, jewelry, or other high-end purchases. 

This loan is also sometimes referred to as a second mortgage. A borrower with 100-percent equity may also take a loan against it. This is known as a first-lien holder transaction, whereby the lender holding this position is the primary creditor. They, in turn, require repayment on this loan above any other debts attached to the property.

Most lenders will only provide mortgages as the first-lien holder, so it’s best to do your research to be certain. 

 

Tax Deductions for Mortgages &
Home Equity Loans

Mortgages and home equity loans offer similar benefits regarding annual income tax return deductions from property taxes and accrued mortgage interest payments. Both can also be applied toward additional items, such as home improvements, or in escrow for upcoming mortgage payments.

Note the Internal Revenue Service (IRS) does have specific stipulations regarding these itemized deductions. According to a February 2018 IRS news release, a home equity loan can be itemized as a tax deduction only if it was used for capital improvements, such as added living space or other upgrades. Note this won’t apply if the loan was used for activities such as debt consolidation or other non home-related expenses

Refinancing With a Home Equity Loan

Due to the novel coronavirus (COVID-19) pandemic and current economic and real estate market conditions, many homeowners are choosing to refinance their current mortgages. A home equity loan is another option for various reasons, among these lower closing costs, additional tax benefits, and no private mortgage insurance (PMI) requirements.

This method is best for those who have a fair amount invested and accrued in their property. The more you can borrow, the quicker you’ll pay down your current mortgage principle, while still having money left over for other expenses, such as renovations and other improvements. 

 

The Takeaway

Understanding which loan is best for your current goals and finances is just part of the process. For additional assistance, it’s best to work with a mortgage lender who can walk you through all the required steps.

 

Contour Mortgage provides lending services throughout the United States. Contact us to learn more about our various home purchase and equity loan products. 

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