When your home is still financed by a mortgage, home equity loans let you borrow money against the value of your property. Due to the fact that they are secured loans with the borrower’s residence serving as collateral, they give access to huge sums of money and are simpler to obtain than other types of loans.
You may be eligible for a home equity loan if the value of your home exceeds the amount you still owe the bank. A home equity loan can provide you with money for any purpose, including your child’s higher education, your business, home improvements or other needs. There is no requirement that the borrowed funds only be put toward domestic expenses. However, there are hazards involved when using your house as a loan guarantee.
A second mortgage loan is a home equity loan. Your home loan used to buy your house is referred to as your “first” mortgage. However, you are still permitted to borrow more money against your ownership stake in that particular property. Home equity loans are used to borrow money against your portion of the first mortgage.
Features of home equity loan
Home equity loans offer an excellent solution to severe financial difficulties with very low-interest rates. Home equity loans are still desirable if the borrower is confident about making the repayments even while the house is at risk. The highlights of this loan include its large loan amounts, extended loan terms, cheap interest rates, and convenience of application. However, these do not imply that this loan should be used for demands that are more optional, such as purchasing a high-end device, travelling abroad, or going on a large shopping spree. As long as the necessity for one can be supported, a home equity loan is acceptable.
Low interest rates
In comparison to other loans like personal loans, business loans, and credit card loans, a home equity loan always has a lower interest rate. This loan is less expensive because it is secured. It is a secured loan since the equity you have in your home is kept as collateral. Because there is less risk involved, the lender can give this loan at a lower interest rate.
Choosing a high loan amount is possible
You must now understand that this loan is being offered in exchange for your equity stake in the property. As a result, the total amount you can borrow depends entirely on the share. In general, you will pay much more than this if you choose to borrow a large sum of money through a personal loan or another source.
Simple approval
Compared to other secured loans, home equity loans are typically authorised faster. With the property’s share serving as collateral, the lenders are safe here. Therefore, they don’t need a lot of intricate processing. The lenders have the right to recoup their money from the collateral in the event that the borrower misses a payment.
Eligibility criteria for home equity loans
- Equity: Your home should have equity that is worth more than 20% of the home’s market price.
- Income: You must have a history of verifiable income going back at least two years.
- Credit score: Just like with any other loan, a low credit score can make it more difficult for you to be approved for one. Ensure that your credit score is 620 or above.
- Debt: Ensure that your debt-to-income ratio is no more than 43%.
- LTV: The loan-to-value ratio (LTV) reveals how much of your existing mortgage you still owe. It should ideally be lower than 80%.
- CLTV: If you apply for a HELOC, lenders will utilise a combined loan to value ratio, or CLTV. Adding the necessary loan to your existing loan balance and dividing the result by the worth of your home will yield the CLTV. You must be eligible with a CLTV of 85% or less according to most lenders.
Calculation of home equity loans
Even while the home loan is being repaid, one can obtain a home equity loan by using the equity or a portion of their home as collateral. When you make EMI payments after your home loan repayment has begun, some principal is paid. Therefore, the principal you have paid as well as the down payment on the property together make up the borrower’s equity or portion in that particular asset. After deducting the value of liabilities owed on an asset, the equity of a home is equal to the asset’s value. Liabilities associated with something always have an impact on its worth.
Consider this example to better understand how the amount of a home equity loan is calculated:
With a home loan of Rs 30 lakh and a purchase price of Rs 40 lakh, your equity is Rs 10 lakh.
Market value of Rs 40,00,000 less loan amount of Rs 30,00,000 equals Rs 10,00,000
You may apply for an Rs 10 lakh equity home loan.
The equity home loan amount will be the same as the market value if your present loan balance is zero.
House equity fluctuates over time, therefore it may increase or decrease depending on the local real estate market. These variations are caused by several factors. Therefore, you must hire a qualified real estate appraiser to calculate your home’s equity for a loan.
Think about this instance,
Your property, which cost you Rs 40 lakhs, is now worth Rs 50 lakh. You have also paid back Rs 10 lakh of the loan amount concurrently. Your equity will then be:
Rs 50,00,000 – Rs 20,00,000 equals Rs 30,00,000.
You may now obtain an equity loan for as much as Rs 30 lakh.
How does home equity loan work?
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A big sum disbursed all at once
The majority of us know and picture a home equity loan as a big sum disbursed all at once when we think of it. Your interest rate is set up front, you receive your entire loan money all at once, and you repay it over the predetermined period of time. The loan balance decreases with each payment. You must make payments until the remaining balance is zero.
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HELOC (Home Equity Line of Credit)
You can obtain approval for a maximum credit line loan amount with a HELOC. You can take out loans from the credit limit as needed. If necessary, you can borrow extra after reaching the loan’s maximum borrowing amount and again after paying off the remaining sum. It functions in a manner similar to that of a credit card and credit line in business loans.
Why should one go for a home equity loan?
There are many benefits to home equity loans that are not available with other types of loans.
- Home equity loans typically have cheaper interest rates because they are secured by your house. The lender is willing to give money at a cheaper interest rate because they are confident that they can get their money back if the borrower defaults on the loan. You may have to repay the loan over an extended period of time because the tenure period may be longer than that of other loans. Your EMIs, or monthly payments, are reduced as a result.
- There is still a chance that you will be approved for a home equity loan even if your credit is poor. Again, the bank isn’t overly concerned about not being able to repay their investment because you’re a homeowner and have a portion of ownership in the property.
- With a home equity loan, you can also be able to receive tax breaks. There is a chance that this will happen, while it is not guaranteed and clearly depends on your specific situation. For qualifying and permitted restrictions, consult a tax advisor.
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