What is a Home Equity Loan?

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Home Equity Loan is the loan that is available to you against the equity on a property. A type of consumer debt, home equity loan is also known as an equity loan, a second mortgage or a home-equity installment loan. It can be availed for any purpose and is available against both residential and non-residential property. The loan amount is calculated on the basis of the current market value of the property.

It is a loan secured by the equity in your home. It means that a bank could let you borrow up to 75% or 80% of the equity in your home (the difference between the home’s market value and the outstanding loan balance on your home).

In order to avail a home equity loan, you need to make sure that you have an excellent credit history, reasonable loan-to-value and combined loan-to-value ratios.

Types of Home Equity Loans

There are two types of home equity loans.

  1. Fixed rate loans
  2. Home Equity Lines of Credit (HELOC)

1. Fixed Rate Loan

Fixed rate loans provide a single lump-sum payment to the individual. The amount can be repaid over a set period at the agreed upon interest rate. The interest rate does not fluctuate depending on market conditions and remains the same over the lifetime of the loan.

2. Home Equity Line of Credit (HELOC)

Home Equity Line of Credit (HELOC) is a variable-rate loan which works similar to how a credit card works. Known as HELOC, this type of home equity loan allows you to borrow a part of the pre-approved amount offered by the bank. The loan may be offered as a bundled package with a credit card allowing you to make withdrawals on the loan or through cheques.

Monthly payments will depend on the amount borrowed and the interest rate. Like a credit card, you can re-borrow the amount repaid. HELOC has a set term like fixed-rate loans. This means that at the end of the loan tenure, the complete outstanding amount has to be settled.

How a Home Equity Loan Works

A home equity loan works similar to a home loan. In both cases, the home serves as collateral. However, for a home loan, the eligible loan amount is up to 90% of the market value of the house. In home equity loan, you convert the equity on your home into cash. Repayment will include principal and interest payments.

Benefits of Home Equity Loan

  1. Easy to qualify for as they are collateral-based loans. You could get approval on the loan even with a poor credit score as this is a secured loan.
  2. Helps utilise the otherwise unused monetary value of your asset.
  3. Helps cover any large expense you may have as the loan amount paid to you is in one lump sum.
  4. Helps plan and manage expenses better as the interest rate is fixed throughout the tenure.

Benefits of Home Equity Line of Credit (HELOC)

  1. Borrow only a part of the credit limit as per your need.
  2. This is a revolving credit facility allowing you to re-borrow the loan amount.
  3. Ideal if payments are to be made in stages as you can continuously withdraw loan amount in parts.
  4. Interest charged only on the borrowed amount.

Documents Required

Businessman/ Self-employed professional:

  • Application form with photograph
  • Educational qualification
  • Identity and residence proof
  • Proof of business existence with business profile and last three years income tax return
  • Last 3 years income statement and balance sheet.
  • Last 3 month’s personal and business bank statements.
  • Processing fee check

6 smart things to know about Home Equity Loan

1) Home equity loan is the loan available against equity in a property, which is calculated on the basis of its current market value.

2) An increase in the market value of the home or a decrease in the outstanding home loan results in a rise in the home equity against which a loan can be taken.

3) The loan is available against residential and non-residential property. It should be fully constructed and should be a freehold property, having a clear and marketable title.

4) A home equity loan can be taken for any purpose, including education of children, marriage expenses, medical expenses, even for refinancing a home loan.

5) The documents establishing the financial and repayment capacity of the borrower have to be provided, along with a photocopy of the documents of the property and a valuation report.

6) A home equity loan does not offer any tax benefits on repayment as is available to the borrower in the case of a home loan.