It’s very rare for a house to be paid for in full at time of purchase. In the real world, most people need some financial assistance and will either take out a loan or get a mortgage. If you’re new to the home-buying game, then you might not have a clear picture on what a mortgage is compared to a line of credit. And even more unclear might be which one is best for you.
Both a mortgage and the home equity line of credit are ways to borrow money that involve pledging your home as collateral. But that’s where the similarities end and it becomes a little more complicated.
What is a mortgage
Most people use the term “mortgage” as referring to the traditional mortgage where a financial institution, like a bank, lends you money in order for you to purchase a residence. A mortgage is considered a standard det instrument that is registered against a property. The bank will usually lend up to 80% of the home’s appraised value or the purchase price, whichever is less. The payment for a mortgage is blended which means that both the principal and interest are paid in each installment. On top of that, amortization periods can go up to 35 years.
The interest rate on a mortgage can be fixed. If you took out a mortgage, you will need to pay back the amount of the loan plus interest over a fixed term.
What if I’m behind in payments
If you are behind in payments, the bank, or lender, can seize your home in a process called a foreclosure. They will then sell the home, often at an auction, to recoup the money.
When is a mortgage better
It makes more sense to take out a mortgage when there is no immediate intent to repay the money. This would be a good option for all of those looking to pay off their loan over a number of years. The majority of people take out mortgages since it has a lower rate. The reason the rate is lower is because standard mortgages have a discharge penalty.
Line of Credit
A line of credit, also known as a HELOC (home equity line of credit), is a type of credit where you can access funds when you need money. It is NOT the same a second mortgage where you take in a lump sum. For a HELOC, you are able to borrow money to pay for a wedding or buy a car. These HELOC funds are available for you to access when you want, however, you cannot exceed the amount set when you first signed for the credit line.
The biggest difference between a mortgage and a line of credit is that a mortgage is used for a single purpose, to fund the purchase of your home. Whereas a line of credit enables you to borrow money for whatever you need, however your home is still used as collateral against default. What you spend your HELOC funds on don’t necessarily have to have anything to do with real estate.
If you sell your home, you will be required to repay what you owe on the HELOC
When a HELOC (line of credit) is better
Where a line of credit is better is when you require total flexibility to draw down a credit line. This means having more flexibility to use your credit and pay it back right away, then repeat. This is a good option for those who have short-term money requirements; particularly on the investment side of things. The increased interest cost becomes irrelevant because of the inherent flexibility in a HELOC.
Since the credit line is secured for a HELOC by a dwelling, the interest charged on what you borrow is generally far lower than what you would pay on an unsecured credit card. The catch is that the home secures the HELOC. If you default, the lender can foreclose on your home.