Home Equity Loan: Benefits, Working Process and Calculation

A home equity loan is availed by homeowners against equity of the house. Such a loan is sanctioned based on the equity of a house. It is an additional loan availed by existing home loan borrowers.

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Home Equity Loan: Benefits, Working Process and Calculation

A home equity loan is also called second mortgage, equity loan and term loan.

What is home equity?

Home equity is the difference between the current value of a house and the outstanding home loan amount.

In a home equity loan, the equity on the house is pledged as collateral. Repayment of such a loan is to be made in monthly installments over and above existing home loan EMIs.

If the home equity loan is not paid off, your house can be auctioned to recover the remaining amount.

Advantages of Home Equity Loan:

• Availing a home equity loan is easy as the house is pledged as collateral.
• Home equity loans have low interest rates compared to unsecured loans like personal loans.
• These loans are sanctioned even if you have a bad credit score.
• Home equity loan gives tax benefits.
• Home equity loans are secured loans which make them less risky for lenders.

How do Home Equity Loans work?

Application and utilization:

• Apply for home equity loans with a lender.
• The lender will go through the application form.
• The interest rates on home equity loans vary across lenders.
• A home equity loan can be utilized in two of the following options:

i. Lump sum: Withdraw the entire loan amount at one go.

ii. Line of credit (HELOC): HELOC stands for home equity line of credit. In this option, a maximum loan amount is approved. You can borrow the amount in parts depending on the requirement.

Interest rate:

• Lump sum option has a fixed rate of interest.
• HELOC option has fluctuating interest rate.

Repayment:

• A lump sum home equity loan has to be repaid in monthly installments.
• A HELOC can be repaid in small installments at your convenience for a few years before making regular payments.
• Home equity is closely related to the current value of a house property, the equity varies with time. Accordingly, home equity can reduce or increase.
• Home equity loans are a boon in a low interest rate regime.

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How to calculate Home Equity Loans?

Home equity loans are sanctioned based on the equity of your house.

Home equity = Current value of the house – outstanding home loan amount.

Home Equity Loan Purposes:

1. Remodeling, renovation or improvisation of a house and property.

2. A home equity loan can be used for college education of a family member.

3. To purchase a second home or land.

4. To consolidate high interest debts.

5. To purchase a vacation home.

6. To purchase an investment property.

7. To start a business.

8. To purchase a vehicle.

What to check before you apply for home equity loan?

1. Check your credit score. Anything above 750 is excellent, 700 to 749 is good, 621 to 699 is fair, 620 and below is poor. Lenders look for a good credit score to sanction a home equity loan.

• 750 and above: You get the best interest rates.

• 700 to 759: You may get a loan if you pledge collateral.
• 621 to 699: You may have to pay high interest rates.
• 620 and below: You may have difficulty in obtaining credit.

If you don’t have a good credit score or have no credit score at all, apply for a secured credit card and use it to build a credit score.

2. Check how much you can borrow. The sum total of the amount you want to borrow and the home loan outstanding shouldn’t exceed 85% of the value of the home.

3. Check your debts. Add monthly payments towards the existing loans and credit card dues.

Can you sell a home if you have an existing Home Equity Loan?

Generally, creditors holding a lien on your property are paid off from the house sale proceeds. Therefore, the home equity loan is normally paid off on the sale of your house.

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