A home equity loan allows you to borrow against the equity you’ve built in a home you already own, while a mortgage is typically used to purchase a new property. Although both options use your home as collateral, they differ significantly in their terms, rates, and risks. Knowing how each one works can help you determine which type of loan aligns better with your financial goals.
How do home equity loans work?
A home equity loan is essentially a second mortgage. It enables you to borrow a lump sum of money using your home as collateral. The amount you can borrow depends on your home equity, which is the difference between your home’s current market value and the remaining balance on your primary mortgage.
Homeowners often turn to home equity loans for significant expenses, such as:
- Debt consolidation
- Major renovations
- Education costs
- Wedding expenses
- Business startup costs
- Medical expenses
Most home equity loans come with fixed interest rates and predictable monthly payments, although some lenders offer variable-rate options.
Home equity loan vs. home equity line of credit
Unlike a home equity line of credit (HELOC), a home equity loan doesn’t have a revolving balance. Instead, it provides a one-time payout that you repay in equal installments.
Is a home equity loan the same as a mortgage?
No, a home equity loan is not the same as a mortgage. A mortgage is the primary loan you take out to buy a home. It places the lender in the “first lien” position, meaning they are first in line for repayment if the property is sold or foreclosed.
In most situations, a home equity loan is a second lien on your home. However, if you own your home outright, the home equity loan can be the first lien since there’s no mortgage.
What are the benefits of a home equity loan?
Home equity loans can be a practical way to turn your property’s value into usable funds. For some borrowers, they offer advantages that other financing options can’t match.
Predictable payments
Most home equity loans come with fixed interest rates, so your monthly payments stay the same for the life of the loan.
Lower rates than unsecured debt
Rates are typically higher than first mortgages but still lower than credit cards or personal loans. This makes them cost-effective for large expenses.
Large borrowing potential
Because the loan is secured by your home, lenders may allow you to borrow more than you could with unsecured financing.
Potential tax advantages
In some cases, the interest may be tax-deductible if the funds are used to “buy, build, or substantially improve” your home. A tax professional can confirm your eligibility.
What are the downsides of a home equity loan?
Like a mortgage, a home equity loan puts your property at risk of foreclosure if you fall behind on payments.
A home equity loan also often adds another monthly obligation on top of existing housing costs, like mortgages. When unexpected expenses or job loss happen, some homeowners find themselves unable to meet the monthly payments.
Other downsides of home equity loans can include:
Higher rates
Home equity loans usually come with higher interest rates than traditional mortgages, reflecting the greater risk for lenders. Rates can range from 5.49% to 10.47%, depending on the loan terms.[1]
Closing costs
In general, home equity loan closing costs for homebuyers are similar to those of mortgages: 2% to 5%.[2] This can make home equity loans less economical for smaller borrowing needs. However, some lenders do offer no-closing-cost loans in exchange for higher interest rates.
Reduced flexibility
Taking equity out of your home leaves less value available for future refinancing or for cashing out when you sell.
Do home equity loans have lower rates than mortgages?
Generally, no, home equity loans do not come with lower rates than mortgages. Mortgage rates are almost always lower because lenders hold the first lien, giving them priority in repayment if you default on your loan. As second liens, home equity loans carry more risk for the lender—translating to higher interest rates.
That said, your exact interest rate depends on factors like the following:
- Broader market conditions
- Your credit profile
- Your home equity
- The loan-to-value ratio (LTV; loan amount vs. home value)
- Debt-to-income ratio
A highly qualified borrower with significant home equity may find the most competitive rates. Still, these are rarely undercut by first-mortgage rates.
Can you use a home equity loan to buy a house?
It’s possible to use a home equity loan to buy a house but it is not common. Most buyers use a traditional mortgage when purchasing a property because lenders prefer a first-lien position. A home equity loan is designed to tap into existing equity, so approval standards and terms aren’t structured around home purchases.
That said, some homeowners do use equity in a primary residence to buy a second home or investment property. They either use it to fund the down payment and then take out an additional mortgage to cover the rest of the cost or they use the cash from the home equity loan to purchase the second home in cash. But as we noted earlier, it could come with higher rates and stricter borrowing limits than a first-lien loan.
Which option makes sense for you?
If you’re buying a home, a traditional mortgage is almost always the right tool. It offers lower rates and longer repayment terms and is specifically designed for home purchases.
A home equity loan makes sense when you already own property and want to access its value for renovations, debt consolidation, or even to help with a down payment on another home. It gives you access to the cash you need without having to refinance, possibly letting you hang on to a low fixed-rate mortgage for longer.
Bottom line: Mortgages and home equity loans are very different
A mortgage and a home equity loan both use your property as collateral. However, a mortgage finances the purchase of a home, while a home equity loan lets you access the value you’ve already built in a home you own.
The right choice depends on your situation. If you already own a home and want to tap into your home equity for home projects or other expenses, a home equity loan may be an option. If you’re buying a property, a traditional mortgage usually offers the lowest rates.