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If you’re planning to buy a home soon, you’re probably confused regarding the difference between mortgage and loan, and how they work when it comes to financing your real estate requirements. Especially, if you’re a first-time homeowner.
To be honest, the terms are often used interchangeably in the banking world. But, there are key differences between mortgage and loan, which you, as a homeowner, should be aware of.
In this loan vs mortgage article, that’s exactly what we’ll talk about — how they’re different from each other in their nature, working, and types.
Difference between mortgage and loan at a glance
A loan is a kind of financial assistance offered to a borrower by a financial institution, usually a bank or credit union. The borrower is liable to pay the principal amount along with an agreed-upon interest on that debt until it’s repaid. There are many different types of loans: personal loans, home equity loans, home loans, student loans, business loans, home equity line of credit (HELOC), mortgages, etc.
A home mortgage, on the other hand, is a type of secured loan given by the mortgage lender to help you finance the purchase of a home. It’s specifically tied to real estate or personal property, such as land or a house. The property against which the mortgage is given is called a collateral.
So, is it better to get a loan or a mortgage? Well, the right answer to that question depends on what the borrowed funds are for. If you’re going to purchase a home or invest in real estate, a mortgage will be your best option.
Difference between mortgage and loan #1: Their uses
A mortgage is specifically about financing a new property. In the case of a mortgage, the lender usually issues a mortgage loan which the new owners of the property must pay. If they fail to pay back the loan, the mortgage lender may be able to foreclose the property, even resell it.
A loan, on the other hand, could be for any purpose. The funds come with a pre-decided interest rate that the borrower must include in their monthly payments.
Difference between mortgage and loan #2: The collateral
The collateral on a home mortgage is the property itself. If ever the borrower fails to pay the loan, the collateral or the property in question may become the lender’s. Basically, a collateral protects the lenders and makes the mortgage a less risky affair.
There are many unsecured loans that do not require collateral at all. In some loans, the lender will require a fixed down payment or cash payment deposit as a form of collateral. Having said that, a loan that comes with collateral such as a home equity loan or HELOC will have much lower interest rates.
The reason is that the collateral gives the lender a kind of assurance that they will not suffer a loss in case of any payment default. Needless to say, the borrowers do everything in their power to make the scheduled payments and pay back the loan.
Difference between mortgage and loan # 3: Types
Both, the loan as well as mortgage, come in different types. Let’s explore all your financial options below:
Types of loans
- Open-end loans vs closed-end loans
Open-end credit or revolving credit is that loan credit which can be borrowed from — more than once. The most common example of revolving credit is that of a credit card. You can continue to borrow from that line of credit till you reach the limit on your card. Of course, you must pay off the card amount every month without fail.
A closed-end credit or a term loan is when you borrow a fixed amount of money with the agreement that you’ll repay it in full at a later date. If any more funds are required, you will have to apply for a new loan.
- Secured loans vs unsecured loans
Secured loans or collateral loans are attached to assets, whereby the lender puts a lien on an asset to recoup their financial losses in the event that the debtor fails on the payments. These include home mortgage loans and auto loans.
Unsecured loans come without collateral and are riskier for the loan lender. And, that’s why, the approval or rejection of loan applications for these loans depends on a borrower’s income, credit history, and credit score. Moreover, these unsecured lines of credit have a smaller loan amount and higher APR.
Read more: First lien HELOC
- Other types of loans under open-end/closed-end and secured/unsecured loans
There are various kinds of loans under this vast umbrella. Some of these include:
- Student loans (closed-end loans, secured by the government)
- Small business loans (closed-end, secured, or unsecured)
- Loans for U.S. veterans (closed-end, secured by the government)
- Mortgage loans (closed-end, secured)
- Consolidated loans (closed-end, secured)
- Payday loans (closed-end, unsecured)
Types of mortgage loans
There are several types of mortgages — with each home mortgage loan type having its own features, pros, and cons. Look at the table below and weigh some of the most common types of mortgages against your financial situation.
Mortgage Type Pros Cons Fixed-rate Loan Fixed monthly principal and interest payments. Helps you set a budget for month-to-month expenses Takes longer to build equity in your home. Higher interest rates with a longer-term loan Adjustable-rate Mortgages (ARM) Lower fixed rate initially. Helps homeowners save substantial money on interest payments Fluctuating rates and monthly payment. Involves a little risk. Difficult to sell or refinance your house if your home value falls Federal Housing Administration loans (FHA Loans) Lower down payment. Government-backed Loan amount limitation. Mortgage insurance is required Veterans Affairs Loan (VA Loans) Government-backed. Flexible loan. Low-interest mortgage. No down payment or mortgage insurance required. A great option for military veterans Only for military veterans and those still serving. Applicable on primary residences only. Stringent loan eligibility, terms and conditions. Includes a funding fee United States Department of Agriculture (USDA Loans) Best for those with a modest income. Lower mortgage interest rates. No down payment required Only for USDA-eligible homes in rural areas. Must include a mortgage insurance. High prepayment penalties Interest-only mortgage Best for borrowers in a strong financial position. Lower monthly payments Requires higher down payments. Strict eligibility criteria such as lower debt-to-income ratios and good credit scores. May require a balloon payment at the end of the loan term
Read more: Do You Need Mortgage Protection Life Insurance?
How are mortgages and loans taxed?
Loans are not taxable income, rather a kind of debt. That’s why, generally, borrowers do not pay taxes on money received from a loan. Also, both the debtor and loan lender do not deduct payment made toward or received from a loan from their taxes. However, when it comes to the loan interest paid, often, these are tax deductibles. Even the loan lenders must treat the interest they receive as part of their gross income.
Buying a house is already exciting and may we say a tad anxious time. You must make your home buying as well as the financing process as well-planned and well-researched as possible. We hope this article will help you understand some of the most important differences between mortgage and loan. You can then select the most viable option for you and your family.