There are two main types of loans to use when borrowing money to buy a home: closed-end loans and open-end lines of credit. According to the Consumer Financial Protection Bureau, 11.5 million home loan applications in 2022 were closed-end and 2.5 million were open-end.
Both types of loans serve different purposes and work in distinct ways, especially in residential real estate banking.
Closed-end loans
Many people refer to closed-end loans as traditional mortgages. They provide a lump sum of money upfront, which the borrower must repay over time, typically with a fixed interest rate. These loans are ideal for individuals looking to buy a home who have a clear understanding of how much they need to borrow.
One important feature of closed-end loans is their fixed repayment schedule. Borrowers make regular monthly payments over a predetermined period, commonly 15 or 30 years. This predictability makes budgeting easier for homeowners, as they know exactly how much they owe each month.
In residential real estate banking, people use closed-end loans for purchasing a primary residence, a second home or an investment property. Lenders evaluate the borrower’s creditworthiness, income and financial history to determine the loan amount and interest rate.
Open-end lines of credit
Open-end lines of credit, are more flexible. They allow borrowers to access funds as needed, up to a predetermined credit limit. Unlike closed-end loans, which provide a one-time lump sum, open-end lines of credit work more like a credit card.
Borrowers can withdraw funds, repay them and then borrow again, as long as they stay within their credit limits. The interest rates for open-end lines of credit are often variable, meaning they can fluctuate over time.
One type of open-end lines of credit investors use in residential real estate banking is home equity lines of credit. Homeowners can use their home’s equity as collateral to secure a line of credit, which they can then use for various purposes, such as home improvements or debt consolidation.
Understanding the differences between these two types of loans can help borrowers make informed decisions about financing their homes.
