Home Equity Mortgage

For many, a home equity mortgage is a term they can interchange with a regular mortgage. Although it functions the same in the sense it allows you to own a home without shelling out hundreds of thousands of dollars, it isn’t quite the same. If using a home equity loan instead of a traditional mortgage is among your list of options, make sure you understand the differences before you close the loan to avoid any unfortunate surprises down the road.

Home Equity Mortgage Basics

A home equity mortgage has many of the same features as a traditional home mortgage. Both loans allow you to buy a home and pay for it over time, typically with terms as long as 30 years. Each loan provides the option of making fully amortized payments over the life of the loan or paying only interest during a set period. Depending on your tax situation, you may even write off your equity loan interest on your taxes each year.

Unlike a traditional home mortgage, special rules govern your home equity mortgage. The state in which you live will maintain equity laws that limit the amount of your loan by either dollar amount or loan to value (LTV) percentage. For instance, if your state maximum LTV is 80 percent, you must ensure your down payment is at least 20 percent of the value if the sales price and value are the same.

Home Equity Mortgage Pitfalls

At times, a home equity mortgage may boast lower closing costs and fees than your typical mortgage can offer, making it more appealing. While these hard dollar savings are important decision factors, this type of loan has distinct drawbacks. If you plan to stay in the home for the life of the loan, you must take time to consider these additional factors.

Depending on your lender, a home equity mortgage does not feature an escrow account. This means saving for your annual property taxes and homeowners insurance is your responsibility. Unless you are a diligent saver, using this kind of loan can lead to financial hardships when you receive these bills.

You also have fewer refinance options with a home equity mortgage. Because this loan must follow home equity laws, your state may prohibit you from taking advantage of adjustable rate mortgages or other programs. A good way to think about this is that once your mortgage is a home equity loan, it is always a home equity loan instead of a mortgage in the eyes of the law. In the state of Texas, for example, you cannot refinance a home equity loan until 12 months pass from closing, potentially precluding you from taking advantage of substantial mortgage rate dips.