Home equity loan vs. mortgage: How are they different?

Having a strong understanding of your options can help you make better financial decisions, particularly when large sums of money are involved — and that’s exactly the case when it comes to home equity financing. Two common tools that people often use are home equity loans and mortgages, and it’s sometimes difficult to tell them apart. 

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Home equity loans are often referred to as “second mortgages” and can also be used to buy new property after all, complicating things further. Let’s take a look at some of the similarities and differences between a home equity loan vs. a mortgage and when you might want to use each option. 

How a mortgage works

When people say “mortgage” without any added context, they’re usually referring to a primary mortgage. It only has one purpose: to allow someone to buy a home. 

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Unless you’re opting for a special home renovation mortgage, all of the loan funds are used to pay the home seller. You don’t get any cash back; everything is used to pay for the home (and closing costs, too, if you won’t be paying those out of pocket). 

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Anyone can take out a mortgage, provided they qualify with sufficient credit, savings, and income to buy the house. Thus, it’s possible for renters or other non-homeowners to get approved for a mortgage, too. 

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Most mortgages are offered for 15 or 30 years with fixed interest rates, although “adjustable-rate mortgages” featuring variable interest rates are often available, too. The home itself also serves as collateral for the loan. If you don’t repay the debt, the lender can foreclose on the home — a rare occurrence (thankfully), but something to remember nonetheless.

How a home equity loan works

A home equity loan, in contrast, can be used for just about anything. You can even use it to buy another home or piece of property. (However, you can’t use it to buy your primary home — that’s what a mortgage is used for). Home equity loans are also called “second mortgages” because, like your primary mortgage, they use your home as collateral for the loan. 

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You can have both a mortgage and home equity loan at the same time, although most home equity loan lenders will only allow you to borrow up to 80% or 90% of your home’s value, minus the balance of your mortgage. This is known as your “home equity,” — i.e., how much of your home you own, without being attached to any other debts. If you own a $400,000 home and still owe $50,000 on a mortgage, for example, then you have $350,000 in home equity that you can borrow against. 

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Home equity loans provide a one-time lump sum that you repay as steady monthly payments, just like your primary mortgage. People commonly use home equity loans to pay for home improvements and repairs, to consolidate higher-interest debt from personal loans or credit cards, or for other large expenses.

Home equity loan vs. mortgage

Let’s dive into the differences a bit more to help you understand how to use these tools. 

Purpose

Mortgage: Funds can only be used to buy a home. 

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Home equity loan: Funds can be used for just about anything. 

Cost

Mortgage: Low interest rates, fixed or variable options available. 

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Home equity loan: Slightly higher rates, generally offered as a fixed-rate loan.

Lien position

Mortgage: First lien position (i.e., first in line to be repaid if you default).

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Home equity loan: Second lien position (i.e., second in line to be repaid if you default).

Loan amount

Mortgage: Varies by loan type and lender. Conventional loans may allow you to borrow up to 80% of the home value, while VA loans may allow you to borrow up to the full value of the home. 

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Home equity loan: Varies by lender. Typically, you can only borrow up to 80% or 90% of your home’s value, minus the remaining balance on your mortgage. 

Repayment

Mortgage: Term lengths range from 15 to 30 years.

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Home equity loan: Term lengths range from five to 30 years. 

Tax deductions

Mortgage: Couples filing joint returns can deduct interest paid on up to $750,000 of home debt ($375,000 for single filers). If you bought your home before 2017, the limit is higher: $1,000,000 for joint filers or $500,000 for single filers.  

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Home equity loan: Same as for mortgages, but you can only deduct the interest if you use the funds to “substantially improve” the home it’s tied to. If you use the funds for other purposes, like debt consolidation, you can’t deduct the interest you pay on the debt.

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Note that in order to deduct interest you pay on mortgages or home equity loans, you’ll need to itemize your deductions rather than take the standard deduction. If you’d pay less taxes overall by taking the standard deduction, then you won’t be able to deduct interest charges, and this benefit may not matter.  

How to decide between a home equity loan and a mortgage

Choosing between a home equity loan vs. a mortgage isn’t always difficult. If you don’t already have a home, then the choice is simple: your only option is to take out a mortgage to buy a home. You can’t take out a home equity loan if you don’t yet have a home. 

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If you’re already a homeowner, you have more options. Assuming you have enough equity in your home to qualify, you can take out a home equity loan for just about anything you want. Using a home equity loan for projects that increase the market value of your home is especially good because it can help you quickly regain some of the equity you lost when you took out the loan. 

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If you’re looking to buy a second home or property, you have a few options:

• Savings + new primary mortgage: Use your existing savings to make a down payment on a new home mortgage, keeping your old and new home debt completely separate. 
• Home equity loan + new primary mortgage: You can take out a home equity loan against your first home to provide a down payment on a new mortgage for your second home. 
• Home equity loan: If you have sufficient equity in your first home, you may be able to pay for a second home outright, without applying for a separate mortgage. It can be faster, but because home equity loan rates are typically higher, you may pay more.

Other home equity alternatives

Home equity loans and mortgages both fit into a larger ecosystem with other home equity financing options. It’s important to know about these tools, as well, so you can make sure you’re not missing out on a better funding option:

• Cash-out refinance: A special mortgage refinance that allows you to take out extra funds in cash when you replace your mortgage with a new, larger version.
• Home equity investment (HEI): A non-debt option that offers lump-sum funding with no monthly payments, which you repay in 30 years along with a portion of your home equity.
• Home equity line of credit (HELOC): A revolving line of credit that allows you to borrow money and only pay interest during a multi-year draw period, to be repaid later during a repayment phase. 

Frequently asked questions

Is a home equity loan the same as a mortgage?

No, a home equity loan is not the same as a mortgage. You can use a mortgage to buy a home. If you already have a home, you can use a home equity loan to borrow against your property and receive cash that you can use for nearly any purpose. 

What is the downside of a home equity loan?

A home equity loan reduces the amount of equity you have available in your home and adds an extra monthly payment to your budget. If you default on it, the lender can foreclose on your home, just like your mortgage lender. 

Are home equity loan rates better than mortgage rates?

No, home equity loans typically have slightly higher interest rates than mortgages. That’s because home equity loans are a bit riskier for the lenders who dole out the funds, so they charge a slightly higher cost to compensate for their risk. 

Final thoughts

Although home equity loans and mortgages sound like similar tools (and, indeed, can occasionally be used interchangeably), they’re not the same thing. A mortgage is used to buy a home, while a home equity loan is used to borrow against a home you’ve already bought. 

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