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How Do Home Equity Loans Compare to Mortgages?

Buying a residential property can be financially demanding. For many, it is simply unrealistic to purchase a home without borrowing money. Fortunately, the market is flooded with different lenders offering funding to purchase a home. Home equity loans and mortgages are two of the most critical types of funding. Most people do not understand the difference between the two. In this article, you will learn how home equity loans compare to mortgages.

Mortgages

A mortgage is generally the funding you get to purchase a residential property. In such situations, you’re the borrower while the lending institution, such as a bank or credit union, is the lender. The amount of money loaned depends on the property’s value. According to Investopedia, you can get a mortgage of up to 80% of the value of the residence you wish to purchase. This value is based on the property’s appraised value or purchase price.

Mortgage Qualification Requirements

If you’re thinking about applying for a mortgage, it is necessary to understand some of the essential qualifications. The following four requirements will help you determine whether you qualify for a mortgage or not.

  • A positive credit score: Most lenders will require proof of a positive credit rating before they accept the mortgage. Moreover, you should also show you’ve made responsible payments before, which assures the lender that you will be able to pay off the mortgage.
  • A down payment: This payment shows your commitment to the lending and acts as an assurance you will not back out before completing the agreement with the lender. Different mortgage lenders will have varying requirements for this funding.
  • A high DTI: Debt-to-income ratio matters because it proves to the mortgage lenders that you can still manage other costs, such as your credit card or a car loan, and those debts won’t get in the way of paying off your mortgage. You can take steps to improve your DTI by finding a side income source or by paying off existing debts.
  • Covering closing expenses: All loans have closing agreements between the lender and the borrower. Mortgage lenders must ensure you have enough money to pay for closing costs. This is similar to a down payment, however, it happens at the end of the process.

Home Equity Loan

Many people assume home equity loans are a type of mortgage. However, home equity loans refer to the funding you get by using your residential property as collateral. You can sometimes call this type of funding a second mortgage because you are borrowing against your home.

The good thing about a home equity loan is that you can use the borrowed amount to finance different expenses, including purchasing a vehicle, making home improvements, and maintaining your home. Nonetheless, it is important to have a plan in place to make timely payments on your loan. Otherwise, you may be in danger of defaulting on your loan, which could lead to the foreclosure of your residence.

Home Equity Loan Qualification Requirements

Home equity loan lenders have various requirements for you to qualify for funding. The good news is that the requirements for a home equity line of credit (HELOC) do not differ much from those of a mortgage. However, they may vary depending on the lender you deal with. Some of the critical requirements for a home equity loan include:

  • A good credit rating: Most HELOC lenders will require you to have a credit score ranging in the mid-600s at the very least. This requirement is relatively easy to accomplish if you take some simple steps to improve your credit rating. This includes things like making your credit card payments on time. On the other hand, it is also possible to get lenders to lower their credit rating requirements if you talk with them about your situation.
  • A 43% or lower DTI: Similar to mortgages, a low debt-to-income ratio is crucial. Most home equity loans will require a DTI that does not exceed 45%. However, different lenders will have varying DTI requirements. Some may be willing to loan you money if your total monthly debts account for about 36% of your income, while others may be willing to negotiate to accept a DTI between 40% and 50%.
  • An adequate income: There may not be specified monthly income requirements for applying for a home equity loan. However, most lenders will want to confirm you make enough money to pay off the loan. This is one way that lenders protect themselves from bad loans.
  • A clean payment history: Lenders will look at your history of paying off loans to determine how trustworthy you are with your finances. If you miss your payments or pay them off late, this will hurt your chances of getting home equity loans. A bad debt repayment history will always turn potential lenders away because it proves you cannot be relied upon to pay off your loan.
  • Your home’s equity: equity means the difference between your mortgage debt and your residential property’s value. This is the figure most lenders use to calculate your LTV (loan-to-value) ratio to ensure you qualify for a home equity loan. Additionally, LTV is critical in how much the lender can grant you. Remember, home equity loans are given when you sign your home as collateral. Therefore, the more valuable the property, the larger the loan you may be able to qualify for.

The Similarities of Both Funding Types

There are a number of similarities between home equity loans and mortgages. They are easily accessible loans that can offer large amounts of money at low interest rates to borrowers that qualify.
 

1. Easily Accessible

Home equity loans and mortgages may have some differences, but they are both popular options among borrowers. One reason for this popularity is their easy accessibility. Banks, credit unions, and other financial institutions are all willing to provide funding to borrowers who qualify. Additionally, the demand for these financing options has skyrocketed. This means that the number of potential lenders has increased over the last few years.

2. Less-Stringent Qualification Requirements

Home equity loans and mortgages have some of the most lenient conditions you can find in today’s financial market. As long as you maintain a positive credit score, clean repayment history, and a low debt-to-income ratio, you will likely be able to qualify for these loans.

3. Higher Loan Amounts

Home equity loans and mortgages often help many borrowers get some of the highest loan amounts. This is because they come from established financial institutions, such as banks and credit unions. Therefore, a home equity loan or a mortgage is a trustworthy source of money. Besides the high loan amounts, most lenders will give you ample time to repay your loan as well.
 

4. Lower Interests

If you lack some of the qualification requirements, you will predictably have to pay more in interest rates and in shorter repayment periods. However, you may be in for a surprise if you have a positive credit score, a low debt-to-income ratio, and a proper loan repayment record. Most lenders will be willing to negotiate the terms because of your track record.

Owning a home is a major milestone in life and is a dream for many. However, there comes a time when you need financial assistance to turn this dream into reality. These are the instances where you should consider getting a mortgage or a home equity loan. The main difference between the two is that you get home equity loans largely based on the collateral of your existing home’s value. On the other hand, a mortgage is based on your debt-to-income ratio and credit history. For both, the amount you receive, repayment period, and interest rates depend on your lender, income, and property value. If you’re considering a home equity loan or mortgage, call Canal Bank today. We would love to help you reach your financial goals.

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