Who doesn’t dream of owning a home? To many, a house of one’s own is a powerful symbol of prosperity and a means of gaining stability and freedom. However, the reality is that most people don’t have the cash or liquid assets to buy a house outright. That’s where mortgages and home loans come in.
Early in the home buying process, people often wonder about the difference between a home loan and a mortgage. You may have seen these terms used interchangeably. Which one should you choose when it comes to a mortgage vs. a home loan?
Definitions of Home Loan vs. Mortgage
A loan is a relationship in which one party (a borrower) borrows money from another (a lender or creditor). Someone may want to borrow money for any number of reasons, such as buying a car, starting a business, or attending a university. Regardless of the purpose, the borrower must pay the borrowed money (principal) back with interest.
Loans can take many forms, including open-ended, closed-ended, secured, or unsecured. A mortgage is a specific type of loan, but not all loans are mortgages.
In theory, a personal loan from a bank or lending company to use toward a home purchase can be called a home loan. In that sense, any loan can be a home loan. However, the most affordable option by far is a mortgage.
The simplest definition of a mortgage is a loan secured by real estate property. Let’s break that down a little further:
Real estate is private property including land and permanent buildings. A home is considered residential real estate, while an office building is commercial real estate.
Any type of secured loan — in this case a mortgage — is one where the borrower agrees to let the lender claim something as collateral if the borrower can’t repay the loan on time. In the case of a mortgage, the property to be purchased or maintained with the loan is also the collateral.
Why Is a Mortgage the Best Loan for Home Purchases?
A home is the largest purchase most people make in their lifetimes. Mortgages make home ownership more affordable by allowing buyers to make a down payment (typically 20%) and pay the rest over a long period at a relatively low interest rate.
Did you know that 87% of home purchases are made using a mortgage?
Interest makes a loan profitable for the lender.
Any time a creditor lends money, they’re taking on a certain amount of risk. If the borrower doesn’t pay them back, they lose money. Lenders offset risk by charging more interest.
Because mortgages are secured, they can be offered with a lower interest rate. Mortgages also use simple interest, which means interest is calculated only on the principal. By contrast, credit card debt and some personal loans use compound interest, where new interest is charged each month on both the unpaid principal and interest.
Average interest rates for different types of loans:
- Credit cards: 15.13%
- Personal loans (24-month): 8.3%
- Mortgages: 5.290%
Note that these rates are subject to change and may not be up-to-date. Mortgage rates change every weekday.
With personal loans, the money you borrow must be returned relatively quickly. These loans typically have a term of two to five years.
Mortgages tend to be written with 15-year or 30-year terms, giving the borrower much more time to repay the loan.
What is a Home Equity Loan?
Two additional terms relevant to the “mortgage vs. home loan” question are “home equity loan” or “home equity line of credit.” These are financial options available to people who already own homes; both are considered types of mortgages.
First, let’s define home equity. Home equity is a form of wealth that comes with home ownership. It’s calculated by subtracting the amount you still owe on your mortgage from your home’s value.
For example, if someone owned a home valued at $300,000 and owed $240,000 on their mortgage, they’d have $60,000 of home equity. A home equity loan or line of credit allows a homeowner to access and spend a portion of that $60,000. A home equity loan is sometimes referred to as a “second mortgage.”
Home equity loans are a popular option for making improvements to a house. As mortgages, they’re secured by the property: the borrower must keep making all payments on their mortgage and home equity loans to avoid foreclosure.
When purchasing a home, most people get a secured home loan called a mortgage. You can repay this loan over 15 years or more at a relatively low interest rate. The affordability of a mortgage compared to other types of loans is just one of the ways homeownership can help you build financial stability.
If you’re considering buying a house, start by contacting a local independent mortgage broker. Access our broker directory to see who’s in your neighborhood!