Loan vs. Mortgage: 6 Key Differences

The terms mortgage and loan are often used interchangeably, but the two have many differences. Loans and mortgages involve borrowing money, but one can be a better choice depending on your goals. This is why it’s important to understand the key differences between loans vs. mortgages.

Mortgages are used for purchasing a new home, and loans can be used for various purposes, such as home renovation, emergency expenses, and car repair. Loans also tend to have a higher interest rate and shorter repayment terms in comparison to mortgages.

What Is a Loan?

Loans are a financial agreement between a lender and a borrower. The lender gives money to a borrower in exchange for you agreeing to make principal plus interest payments. There are several different types of loans, such as secured, unsecured, revolving, and term loans.

When you borrow a loan, you agree to the lender’s terms to pay it back over time with interest. You’ll typically have fixed payments with a term loan. However, with a revolving loan, such as a line of credit, you can withdraw money as needed within your credit limit and then make repayments to allow additional withdrawals.

What Is a Mortgage?

A mortgage is a type of loan where your home is used as collateral. Mortgages are secured loans because the property you’re purchasing is tied to the loan terms. This means that if you don’t repay your mortgage debt, the lender can sell the property to recover the money.

A mortgage can be used to purchase or refinance a property. Mortgage requirements are stringent, and lenders will review your credit history, debt-to-income ratio, and income and determine the value of the property you plan to purchase before deciding to lend money. Since loan amounts are quite high, mortgages often have longer terms, ranging from 15 to 30 years.

Loans vs Mortgages: The 6 Key Differences

The best way to determine what type of loan you should borrow is by understanding the key differences between loans vs. mortgages.

1. Purpose of Borrowing

One of the main differences between loans and mortgages is the purpose for which each can be used. Mortgages are used for purchasing real estate, while loans are versatile and can be used for home renovations, business, vacations, medical expenses, and more, depending on the loan type. Knowing the reason for borrowing will make it easier to determine which product is better.

2. Collateralization

Mortgages are secured loans, while loans are typically unsecured. When you get a mortgage, the lender will use the property you’re purchasing as collateral. If you fail to make payments, the lender can foreclose the property to recover the money.

Loans are usually unsecured, but some lenders may also offer secured loans where you can use a vehicle, equipment, or other assets as collateral. Since the lender has more risk when offering unsecured loans, they charge higher interest rates.

3. Loan Repayment Terms

Mortgage loans usually have very long repayment timelines because the amount you borrow is large. Some of the most common fixed-rate mortgage terms are 15 to 30 years. Loan amounts are usually smaller, so they’re paid back in a shorter time frame of up to seven years.

4. Interest Rates

Loans are usually unsecured, so lenders don’t have the same protection as mortgage providers. For this reason, loans usually have higher interest rates compared to mortgages. For example, personal loans have an average interest rate of 21.77%.

Several types of mortgages, such as fixed-rate or adjustable-rate mortgages, are typically less expensive than loans. For example, the average 30-year mortgage interest rate is 7.92%. FHA, VA, and some first-time homebuyer loan programs may offer lower rates.  

5. Loan Amounts

Lenders decide on a mortgage amount based on the borrower’s income and the property’s value, so the loan amounts are much larger. Loans may have lower maximum borrowing limits compared to mortgages.

For example, personal loan amounts can range from $600 to $100,000, depending on the lender and your income, credit score, and debts.

6. Flexibility

Loans are more flexible when it comes to using funds, qualification, and repayment loans than mortgages. Personal loans can be used for any purpose, while mortgages can only be used for purchasing real estate.

Personal loan lenders also have less stringent eligibility requirements. Since mortgages are large amounts, mortgage lenders have strict qualification guidelines. There may also be several restrictions on the repayment of loans, such as prepayment penalties with mortgages.

Pros and Cons of Loans and Mortgages

You can also evaluate loans vs. mortgages and which option might be better for you based on the pros and cons of each option.

Pros of Loans

• Loans usually have fast approval and funding times, making them useful when you’ve got an emergency.
• You won’t need collateral for an unsecured loan to get approved.
• Loans are more flexible, so you’ll be able to use the funds for any purpose.
• The repayment terms are shorter, so you’ll be able to pay off the loan sooner.

Cons of Loans

• The interest rates can be higher, especially if you don’t have good credit.
• The penalties and fees can be high, making the total loan cost higher.
• The loan amounts can be much smaller, so you may not be able to fund large purchases.
• If you fail to repay the loan or miss multiple payments, it can damage your credit score.

Pros of Mortgages

• The interest rates for mortgages are much lower than other types of loans.
• The repayment terms are longer, making the loan more affordable.
• Homebuyers can build equity in real estate through a mortgage.
• You may be able to get tax benefits through mortgage interest deductions.

Cons of Mortgages

• You’ll need a down payment and closing costs for a mortgage, so the upfront costs may be high.
• If you fail to repay the loan, there is a risk of foreclosure.
• You’ll be committed to monthly payments for a longer period of time.
• You’ll only get the mortgage note and ownership of the property once you’ve paid off the loan in full.

Which Should You Choose?

The right option for you will depend on what you need financing for. Loans can be used for a wide range of reasons, while mortgages can only be used for real estate.

Borrowing on an ordinary loan may be better compared to a mortgage if you want money for home renovation projects and upgrades. You can also borrow on an ordinary loan for large expenses or for debt consolidation.

Mortgages have specific uses, so you should consider them when you want to be a homeowner or want to purchase an investment property. If you own a home, you can also borrow on a home equity loan, which is essentially a second mortgage.

It’s best to consult with a financial advisor, mortgage broker, or loan officer to determine which loan option will be best for you based on your individual circumstances.  

“The key factor in any loan you choose to apply for is making sure you can repay it according to the terms offered by the lender,” says Brad Reichert, debt expert and founder and managing director of Reichert Asset Management LLC.  “If you suddenly face financial hardship, you can get into trouble just as easily with a low, fixed-rate mortgage loan as you can with a high-rate, unsecured personal loan or revolving line of credit,” Reichert explains.   

Reichert shares that it's best to compare loan rates and terms in the current market to make sure you select the very best loan for your needs and current financial situation. "Being able to borrow below your means and having an adequate emergency reserve fund will ensure you won’t run into issues once you start making payments," says Reichert.

The Bottom Line on Loan vs. Mortgage

Mortgages and loans can both help you achieve different financial goals. However, they’re designed for different purposes.

A loan is a good option when you want flexibility in the use of funds and if you want to borrow for a short term. A mortgage may be a better choice if you want to purchase real estate, want a lower interest rate, and have a longer repayment period.