HELOC vs mortgage: What's the difference?
Please note: Discover® Home Loans offers a home equity loan product, but does not offer HELOCs.
If you've been looking at various types of home loans, you might be wondering about the differences between a home equity line of credit (HELOC) and a mortgage.
You can use both loans to finance your needs, but they have different purposes and benefits. Here's a look at what sets them apart from each other.
HELOC vs mortgages
- A mortgage is a loan used to finance the purchase of a home, typically over 15 to 30 years, with monthly payments consisting of principal and interest.
- You may refinance your mortgage to get a lower interest rate or tap into your equity.
- A HELOC is a line of credit that uses the equity in your home as collateral and can be drawn on as needed up to the credit limit.
- A HELOC is considered a second mortgage and usually has a variable interest rate.
- Most HELOCs have what's known as a draw period during which you can make only interest payments before entering repayment phase.
What is a mortgage?
A mortgage is a loan that helps you finance the purchase of a home. When you take out a mortgage, you agree to repay the loan over a set period, typically 15 to 30 years. Each month, you'll make a payment towards the principal (the amount you borrowed) and the interest (the cost of borrowing the money).
If you already have a mortgage, you may be considering a refinance. A mortgage refinance is when you replace your existing home loan with a new one. Typically, people refinance their mortgage to get a lower interest rate, which could save them money over the life of their loan.
However, there are other reasons to refinance as well. For example, some people refinance to tap into their equity — that is, the portion of their home’s value that they own outright.
A second mortgage is a loan that uses your home as collateral. The advantage of a second mortgage is that it may come with a lower interest rate than other types of loans, like unsecured personal loans. As a result, it can be an attractive option for homeowners who are looking to consolidate debt or make home improvements.
However, it is important to remember that a second mortgage is still a loan, and you will need to make regular payments to avoid defaulting and losing your home.
What is a HELOC?
A HELOC is a type of loan that also uses the equity in your home as collateral. With a HELOC, you may be able to borrow up to 90% of the value of your home. The loan is typically structured as a line of credit, which means you can draw on the loan funds as needed, up to the credit limit.
READ MORE: HELOC: Home Equity Line of Credit Handbook
Is a HELOC a second mortgage?
Unlike a refinance that replaces your current loan, a HELOC is typically a second mortgage.
When you take out a HELOC, you are effectively taking out a second loan against your home — albeit there some key differences between a HELOC and a traditional second mortgage.
For example, a HELOC typically has a variable interest rate, while a more traditional second mortgage, like a home equity loan, usually has a fixed interest rate.
Additionally, with a HELOC, you can generally borrow smaller amounts of money over time, while with a home equity loan you borrow a lump sum all at once.
Overall, both loans use your home equity as collateral and are types of second mortgages.
HELOC draw periods
Most HELOCs have what's known as a draw period that can last between 5-10 years and during which you borrow money against your home equity.
After the draw period ends, you'll enter the repayment phase. Then, you'll need to repay the outstanding balance plus interest. Understanding how the draw period works is essential to making the most of a HELOC.
During this time, you'll be able to make interest-only payments, but there's no need to repay any principal until the end of the draw period. This gives you some flexibility in how you use your HELOC.
For example, you could use it for a one-time expense, like paying for major home repairs. Or, you could use it as a revolving line of credit for ongoing costs, like funding your child's college education.
Knowing how much you can borrow and when you'll need to repay it is crucial to making smart financial decisions with a HELOC.
Main differences between a HELOC vs mortgage
Fixed rate first mortgages are typically long-term loans. The fixed rate means that the monthly payments will remain the same for the life of the loan, making it easier to budget for your mortgage payments.
On the other hand, HELOCs are typically comprised of a draw period and a repayment period that together may span a total term of 20-25 years with variable interest rates. This means that your monthly payments could go up or down depending on changes in the market and how much you borrow.
Both mortgages and HELOCs have their advantages and disadvantages. It is important to speak with a lender to determine which type of loan is right for you based on your unique circumstances.
Other types of mortgage loans
If you feel like neither a mortgage nor a HELOC is right for you, there are some alternatives you may consider:
Home equity loan
A home equity loan is another type of loan that allows you to borrow against the equity in your home. Home equity loans are typically fixed-rate loans, meaning the interest rate will remain the same for the life of the loan. Home equity loans are a good choice for homeowners who need a large amount of money for a one-time expense, like a major home repair or renovation.
With a home equity loan from Discover, you may be eligible to borrow $35,000 to $300,000 in one lump sum, secured by the equity in your home.
Cash out refinance
A cash out refinance is a type of mortgage loan where you refinance your existing mortgage and take out a new loan for more than you owe on your home. The difference between the two loans will be given to you in cash, which you can use for any purpose. Cash out refinances typically have higher interest rates than other types of mortgages, so they should only be used if you are confident that you can make the higher payments.
A cash out refinance calculator can give you an idea of how much cash you may be able to get out of your home.
Personal loans are unsecured loans that can be used for various purposes, including consolidating debt, making home improvements, or funding a large purchase. Personal loans typically have fixed interest rates and terms, meaning that your monthly payment will stay the same for the life of the loan.