Home Equity Loans allow you to borrow against your home’s value when your home is still under home loan tenure. They provide access to large amounts of money, and are easier to get than other types of loans as this is a secured loan and the house of the borrower is the collateral.
If your home worth is more than you owe to the bank for it, then you can get a Home Equity Loan. A Home Equity Loan offer you funds for anything you want such as for higher education of your child, Business, home expansion or any other personal need. There is no restriction that the borrowed money should only be used for home-related expenses. However, when you use your home to guarantee a loan, it comes with risks.
A home equity loan is a Second Mortgage Loan. The “first” mortgage is your home loan with which you purchased your home. But you can still take an additional loan against your share in that particular property. Borrowing against your share in 1st mortgage itself is known as Home Equity Loans.
One can take a Home Equity Loan by keeping the equity or share of his/her home as collateral even when the home loan repayment is going on. After your home loan repayment has started, when you pay the EMIs some amount of principal is paid. So the principal amount which you have paid and the down payment of the property together form the equity or the share of the borrower on that particular asset. The Equity of a home is equal to the value of an asset after subtracting the value of liabilities on the asset. As value of anything is always affected by the liabilities attached to it. Hence, the equity of an asset is found by this equation:-
Equity= Value of asset- Liabilities on the asset
Let’s understand this with an example:
| Home Purchase price | ₹30,00,000 |
| Amount borrowed | ₹25,00,000 |
| Down payment/equity | ₹5,00,000 |
| After 4 Years | |
| Principal amount borrowed | ₹25,00,000 |
| Principal repaid | ₹5,00,000 |
| Amount owed | ₹20,00,000 |
| Home’s appraised value | ₹35,00,000 |
| Amount owed | ₹20,00,000 |
Hence, Equity = ₹15, 00,000
But there are cases where the value asset reduces with time, and it may be possible that the equity can have a negative value. In such particular case you can’t get any Equity Loan. For an equity loan the equity of the borrower should always be positive and it should be a minimum of 20%.
Why Should You Go for A Home Equity Loan?
Home equity loans have many advantages which are not available with other types of loan.
As Home Equity Loans are secured by your home, you can usually get this loan at a lower interest rate. The lender knows that they can recoup the funds if the borrower defaults on the loan, so they’re ready to lend out money at a lower interest rate. The tenure period may also be longer than other types of loans so, you have to pay off the loan for long term. This lowers your monthly payment i.e. your EMIs.
Even if you have bad credit there are chances that you’ll qualify for a home equity loan. Again, since you’re a homeowner and you have share/equity in the property, the bank isn’t much concerned about not being able to recoup their fund.
You may also qualify for tax deductions with a Home Equity Loan. This is not guaranteed but it obviously depends on your individual circumstances, but there is a possibility for this. Consult a tax advisor for qualifications and allowable limits.
How does it Work?
- A lump Sum Disbursed all at Once – This is what most of us know and have in our mind when we think of a home equity loan. Your interest rate is decided in the beginning, you get the full loan amount at the start all at once, and you repay the loan over the tenure decided. Each repayment reduces the loan amount. You need to pay until the balance amount becomes 0.
- A Home Equity Line of Credit (HELOC) – Through a HELOC, you get approved for a maximum amount to borrow on a credit line. You can borrow according to your need from the credit limit. When you borrow up to the limit of the loan and as you pay down the balance, you can borrow more and can borrow again if needed. It works the same was as a credit card and credit line as in Business Loan.
Features of Home Equity Loans
Low Interest Rates
A Home Equity Loan always comes with lower interest rate as compared to that of other loans such as personal loan, business loan, and credit card loan. The reason that makes this loan cheaper is its secured nature. The share you have on your house is kept as collateral which makes it as a secure loan. The lender find less risk is lending for this loan and hence offered at cheaper rates.
Can be opted for High Loan Amount
It must be clear to you now that this loan is offered against your share in the property. Hence the amount which you can borrow completely depends on the share. Generally when you will go for a high amount borrowing in a personal loan or other it will cost you much more compared to this.
Easily Approved
Home Equity Loans generally get approved in less time as compared to that of other secured loans. The lenders here are secure with the share of property as collateral. So, they don’t require much detailed processing. In case if the borrower defaults with the repayment the lenders has the authority to recover their money from the collateral.
Potential Tax Benefits
Tax benefits can also be availed by some of the borrowers. But it completely depends on the reason behind borrowing and many terms and conditions are involved in this.
Closing Cost
It depends on lender to lender. Some charge a closing fee while a few don’t. Generally the closing cost depends on the loan amount, appraised value of the property and so on. The borrower should check for this point before borrowing only.
Downside of a Home Equity Loan
First and foremost you should know that, if you fail to repay your loan. Your lender has the authority to seize your house and sell it to recover the money they lend you. This is the heart of Home Equity Loan. Your share of house is the collateral. But, this is a worst case scenario, but it certainly needs to be kept in mind before you go for it. If you see positively this can be a good thing though in the sense that it motivates you to keep you timely with your payments.
Things You Should Do Before Going for a Home Equity Loan
Check Yourself, Do You really Need this Loan?
Choosing a Home Equity Loan you put your house as collateral. Hence a risk factor gets involved here. You can lose your home in case of defaulting on the payments. So, go for it when you really need a loan and you are left with no other option.
To Shop around is a Must
Before you opt for the loan with any particular lender to shop around is a must to do thing. Check with different lenders for the rate of interest and other charges. Choose the one which you find best in terms and policies too.
Be Ready with All the Documents
When you would go to the lender they would ask for different documents including bank statement, property papers, documents for appraised value of the property and documents showing your repayments. So, be ready with all these documents.
Map Your Income and Expenses
Any loan adds an extra expense on your monthly budget as you have to pay the EMIs now. So, mapping of your income and expense should be done before you go for it. You should not go for it if you can’t afford it, as your home is at a high risk in this loan.
Home Equity Loans are a great option to come out of big cash crunches at very reasonable interest rates. Though the house is at risk but if the borrower is sure about the repayments, Home Equity Loans are worth it. High loan amounts, longer tenures and low interest rates and the ease of availing are the highlights of this loan which makes it worthy of choice. But these do not mean that this loan be availed for the needs which are more of a choice, like buying a high end gadget or a vacation abroad or a big shopping spree. A Home Equity Loan is justified as long as the need for it is justified. Home Equity Loans are available from all the top lenders in India with different features and benefits, hence someone planning to avail it should definitely check around and choose the lender which best suits the requirements. A Home Equity Loan lets your home provide you a cover in more than one way.
