A home equity loan is also known as an equity loan, home equity installment loan, or second mortgage. The loan allows homeowners to borrow against the equity in their property. This loan is typically offered on a fully constructed property with a clear title. The loan amount is based on the difference between the current market value of the property and the owner’s mortgage balance due. Make sure you have an excellent credit history and desired loan-to-value ratio.
Types of Home Equity Loan
Fixed Rate Home Equity Loan
Fixed-rate loans provide a single, lump-sum payment to the borrower, which is repaid over a set time. The loan amount can be repaid over a set period at the agreed interest rate. In such loans, the rate of interest does not fluctuate depending on the market conditions and remains the same over the loan tenure.
Benefits of Home Equity Loan
Home Equity Lines of Credit (HELOCs)
A home equity line of credit or HELOC is a line of credit that works like a credit card. With such a loan, applicants can borrow up to a specific amount of home equity and repay the funds over time as per their convenience.
Benefits of Home Equity Line of Credit
How a Home Equity Loan Works?
A home equity loan works similarly 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. Whereas, with a home equity loan, you can convert the equity on your home into cash. Repayment will include principal and interest payments.
How to Calculate Home Equity?
Home equity loans are disbursed by the lenders after considering the house equity, which is the difference between the value of the home and the liabilities payable towards the home. The formula, to calculate home equity is given below:
Equity = Current value of the house – the total outstanding amount payable towards the loan
Let us understand this with the help of a simple example along with the calculation-
Suppose you have purchased a house worth Rs. 50 lakh and have taken a loan for Rs. 40 lakhs, then the current equity of your house will be Rs. 10 lakhs. Breaking it down,
Value of the house (50,00,000) – Total loan payable (40,00,000) = Equity (10,000)
In a few years, let us assume that the house value has increased to Rs. 75 lakh and you have paid off half of your loan. You are now left with only Rs. 20 lakhs in loan payments while the value of the house has increased. Therefore, the equity of the house will also increase in this case. The equity of the house will now be:
Current house value (75,00,000) – Total loan payable (20,00,000) = Equity (55,00,000)
As represented above, the equity of the house varies from time to time and it can be reduced as well. If the real estate market drops drastically in a certain area, in that case, the value of your house in that locality will also drop. This will, in turn, adversely affect the equity of your house.
Note: If the home you own has no loan obligations, then the equity will be based on the home's market value.