Home equity loans vs. Purchase mortgage loans

Young family in front of their home that is financed with a mortgage.

A purchase mortgage loan can be used to buy a home, while a home equity mortgage loan (or home equity loan) lets you borrow funds using your home as collateral.

A home equity loan is sometimes called a “second mortgage.” It allows you to tap into your home’s equity (the current market value of your home minus the amount you still owe on your purchase mortgage loan) to receive cash.

Some borrowers use a home equity loan to consolidate debts, while others use it to pay for home upgrades, college expenses, or even a vacation.

Below, we’ll dive deeper into the differences between a home equity loan vs. purchase mortgage loans.

What is a purchase mortgage loan?
What is a second mortgage?
What is a home equity loan?
What is a home equity line of credit?

What is a purchase mortgage loan?

A purchase mortgage loan can help you buy a house or another piece of real estate. It may have a fixed or variable interest rate.

To obtain a purchase mortgage loan, you normally need to put down at least 3% of the total price of the home. However, many lenders require a down payment of 5% or more.

To see what your current income and expenses may allow you to afford for a new home, use the home affordability calculator from Discover® Home Loans.

Principal, interest, taxes, fees, and insurance

When you take out a purchase mortgage loan, your monthly outgoings may include:

Principal: The total amount of money you borrowed to buy the home.
Interest: The price you pay to borrow the money for as long as you have the loan.
Taxes: The property taxes (and other taxes) you pay as a homeowner.
Private mortgage insurance (PMI): If your down payment is less than 20% of the total price of the home, you may need to pay for PMI to cover any potential default against the purchase mortgage loan.
Home insurance: This may cover losses and damage to your home.

Pre-approvals

If you’re in the market for a home, getting pre-approved for a mortgage might be a good idea. With pre-approval, you may be able to find out the maximum purchase price you can afford while house hunting.

If you do go through the pre-approval process, you can expect a lender to check your credit report, debt-to-income (DTI) ratio, and other parts of your financial profile to qualify you for a loan amount.

Different types of purchase mortgage loans

The most common types of purchase mortgage loans include:

Conventional: A conventional loan is a mortgage not guaranteed or insured by a government agency. Some lenders may offer these loans with as little as a 3% down payment. PMI is generally required if the down payment is less than 20%.
Veterans Affairs (VA): A VA loan is designed for veterans and backed by the United States Department of Veterans Affairs. It can allow veterans and their families to buy a house with 0% down (if the sale price isn’t higher than the home’s appraised value) but may require a VA funding fee.
Federal Housing Administration (FHA): An FHA loan is insured by the Federal Housing Administration and allows borrowers to put down as little as 3.5% of a home’s purchase price.
United States Department of Agriculture (USDA): A USDA loan is intended for borrowers in rural areas and sponsored by the USDA Office of Rural Development. This loan typically does not require a down payment.

Couple with a mortgage discussing taking out a second mortgage in the form of a home equity loan to finance home improvements

A loan you can take out against an already mortgaged home is known as a second mortgage

What is a second mortgage?

A second mortgage lets you tap into the equity in your already mortgaged home to meet your financial needs. The amount you can take out may depend on your available home equity, income, credit score, lender, and other factors.

Two types of second mortgages

A home equity loan and home equity line of credit (HELOC) are two different types of second mortgages. The differences between a home equity loan and a HELOC are discussed in a later section below.

Low interest rates

With a second mortgage, you’re likely to lock in a lower interest rate than you would with some other types of financing, such as a personal loan. However, these products use your home as collateral, meaning your property could be at risk if you fail to make payments.

What is a home equity loan?

With a home equity loan, you can access your home’s equity in a lump sum. Lenders may allow you to borrow a specified amount of your available equity, and you can use the funds at your discretion. You will normally repay your loan through fixed monthly payments over a term of typically anywhere between 10 and 30 years.

Fixed interest rate

A home equity loan typically comes with a fixed interest rate that may make it easy to budget for monthly payments.

Lump sum

Since you get your money in one lump sum, you may be able to use a home equity loan to cover a large expense right away, such as an unexpected bill.

Tax deduction

If your main or second home secures your home equity loan, and you “buy, build, or substantially improve” that residence, you may be able to deduct the interest you pay each year on the loan. This is subject to certain dollar limitations and other conditions. For more details and to see if you’re eligible for a deduction, reach out to a tax professional.

Discover offers home equity loans that range from $35,000 to $300,000 with low fixed rates and zero application, appraisal, or origination fees.

What is a home equity line of credit (HELOC)?

Just like a home equity loan, a HELOC can let you borrow money against your home’s equity. However, a HELOC differs from a home equity loan because it’s similar to a credit card in some ways. Instead of receiving a lump sum, you may borrow repeatedly against your available home equity and only make payments and accrue interest on the amount you withdraw.

Variable interest rate

Some lenders offer variable-rate HELOCs. This rate can fluctuate over the life of the HELOC term depending on how market rates rise and fall and other factors. A variable interest rate may make it difficult to budget for your monthly payments, which can increase or decrease over time.

Only pay for what you borrow

With a HELOC, you only pay for the money you borrow, and lenders normally only charge interest on your withdrawals. This may be a good choice if you want to access cash when you need it or if you have an ongoing home improvement that doesn’t have a fixed price.

Draw period and repayment period

During the draw period of a HELOC, you can draw on your line of credit and typically only pay interest on what you borrow. After the draw period is over, the repayment period (which generally lasts between 10 to 15 years) will begin. You typically cannot draw from your line of credit during the repayment period.

Depending on your circumstances, a home equity loan may be more beneficial. You may also be able to refinance a HELOC into a new home equity loan with a fixed rate.

Please note: Discover does not offer purchase mortgage, VA, FHA, USDA, variable rates or HELOCs but does offer home equity loans with $0 charges at closing.

Main: The information provided herein is for informational purposes only and is not intended to be construed as professional advice. Nothing contained in this article shall give rise to, or be construed to give rise to, any obligation or liability whatsoever on the part of Discover Bank or its affiliates.