A home equity loan, also known as term loan, a second mortgage, or equity loan, is an additional loan availed by an existing housing loan borrower. The borrower lends the additional amount to the existing HOME LOAN holder after considering the equity of his/her house. Equity, in the scenario, can be defined as the difference between the current value of the house and the total amount due towards the housing loan. The equity on the house is used as collateral in attaining a home equity loan. The instalments on these loans are payable monthly on top of the monthly installment one already pays towards their existing home loan, therefore the term ‘second mortgage’.
For example, let us say that Mr. X purchases a house worth Rs.1 crore. He avails a loan of Rs.80 lakh and makes a down payment towards the house of Rs.20 lakh. Initially, on the day that the house is purchased, the equity of the house is equal to the down payment, i.e. Value of the house (Rs.1 crore) – the amount owed (Rs.80 lakh) = equity (Rs.20 lakh).
Five years later, after loyally making the EMI payments [Use HOME LOAN EMI CALCULATOR to compute your Home Loan EMIs.] towards the loan, Mr. X now only owes Rs.65 lakh to the bank, while the value of the house has now risen to Rs.1.5 crore. In this case, the equity of the house is Rs.85 lakh: Value of the house (Rs.1.5 crore) – the amount owed (Rs.65 lakh) = equity (Rs.85 lakh).
6 Benefits Of Home Equity Loan
- Home equity loans are generally easier to attain as these loans are dispensed using your home as collateral. Home equity loans are considered to be secured loans and are therefore easier to attain.
- Home equity loans usually have low interest rates when compared to unsecured loans. This helps an individual borrow money at an economical rate.
- These loans have a higher chance of being approved in case of a bad credit score.
- Attaining a home equity loan can help with tax deductions. However, it must be noted that not everybody is eligible for tax benefits.
- A large amount of money can be borrowed with home equity loans since your house itself stands as collateral.
- Since house equity loans are secured loans, they are, in a sense, safer for lenders as well. Therefore, lenders will be more inclined to approve these kind of loans.
How Does A Home Equity Loan Work?
Applying for a loan
The rates on interest on home equity loans vary from place to place. One must therefore visit multiple lenders before finalizing. Upon request, the lender will go through their regular approval procedure like checking your credit score, etc. This may take a couple of days, and if approved, the money will be disbursed after a couple of weeks.
Upon approval of a home equity loan, an individual may choose to utilize the money in either of the two options mentioned below:
- Lump sum – An individual may borrow the entire amount that a bank is willing to lend him/her. This is a lump sum withdrawal under home equity loan and will have a fixed rate of interest which can be paid on monthly instalments, like a regular loan.
- Line of credit (HELOC) – A home equity line of credit is when a borrower only borrows a part of the maximum amount approved by the lender and is available to him/her. Also called Home Equity Line of Credit or HELOC in short, this type of home equity loan allows a borrower to borrow several times depending on his/her requirements. Not only is this the more flexible option, but this also permits the borrower to make smaller payments towards the loan. The interest rates on HEOCs are usually variable in nature and therefore interests are bound to change over time.
Repayment
The repayment of the loan depends on the type of home equity loan you have opted for. For a lump sum equity loan, you will usually have to make monthly payments until the loan amount is settled. Whereas, for a line of credit of a HELOC, you are allowed to make small payments, at you convenience, for several years before having to make regular payments.
How To Calculate Home Equity Loans?
Home equity loans are disbursed by lenders after considering the equity of your house. Home equity, in simple terms, is the difference between the value of your home and the liabilities payable towards the home. The formula, therefore, is:
Equity = Current value of the house – the total loan payable towards the house