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Home Equity Loan - Types, Benefits, and Differences

22-Oct-2024 | Home Loan

Home Equity Loan - Types, Benefits, and Differences

A smart investment for the future representing stability and safety comes from owning a home. Owning a home goes beyond just being a place to live, that home may also help you financially. In this context, home equity loans come in, which let homeowners borrow against the value they’ve built up with their homes. Along with that, homeowners can also fund significant expenses like home renovations, asset allocation, debt consolidation, or many other related costs.

In this blog, we will come to know about home equity loans, their types, benefits, and key differences.

What is a Home Equity Loan?

home loan is a type of loan that allows homeowners to use the equity they’ve built in their property as collateral for borrowing money. You can borrow a lump sum, with a home equity loan. It is usually at a fixed interest rate, which is payable over a specific period. The borrowed money can be used for different purposes such as fixing up your house, paying off other debts, or covering other major expenses. We can understand this with the example:- if your home is worth 40,00,000 and you owe 20,00,000, you have 20,00,000 in equity.

Types of Home Equity Loans

There are mainly two equity home loan types, which are defined as follows:

Lump-Sum Home Equity Loan

This home equity loan provides a single, fixed amount of money to homeowners, which is secured by the equity in your home, which means your house serves as collateral. Under this, interest rates remain the same for the entire tenure of the loan, which makes your monthly payments predictable. This is mostly used for large, one-time expenses where you need a fixed amount of money. It is used for home renovations, medical expenses, or debt consolidation.

Home Equity Line of Credit

In contrast, a home equity line of credit is similar to a credit card, it has a flexible credit line. Under this, the interest rate is variable and may change based on market conditions. A HELOC is suitable for ongoing and fluctuating expenses where you might need funds over time. In this, the lender determines the duration of the draw period, which allows you to access the funds with variable interest rates that vary according to an index such as the prime rate.

How a Home Equity Loan Work?

A home equity loan operates like a conventional home loan, utilizing property as collateral. Here’s how it works-

  1. Applying for the Loan: At that time when you get a home equity loan, the initial step starts by filling out an application for a loan with a lender or a bank. Your house will kept as collateral security, which is pledged by the applicant. 

  2. Valuing Property: After applying for a loan with a lender, the financial institution analyses your house or property kept as collateral to determine its current market value. At that time, the lender keeps an eye on various factors like the location, area, condition, and value of your property or house to figure out the loan amount that could be sanctioned. 

  3. Approval: After calculating the valuation of your property, the lender decides the amount that you are eligible to avail. Lenders calculate this value by valuing your house as per the market value or condition of the property and the remaining mortgage is subtracted.  

  4. Repayment: After getting the loan you need to repay it over a specific time, which is usually through specific monthly payments. These monthly payments of repaying the loan are called EMI (equated monthly installments), this includes both the original loan amount and the cost of borrowing (interest). The repayment period is set for several years, which can be varied.

Note: This type of loan is useful for large expenses, such as home improvement, medical bills, education, and many more.

How to Calculate Home Equity?

By following some steps calculating home equity becomes an easy process. The steps are as follows:

  1. Market Value: Firstly, you need to know the market value of your house. By using some professional appraisal methods and by doing some market research you can find out the current market value of your property.

  2. Any Outstanding Loans: After evaluating the market value, you need to look at how much money you still owe on your home loan, which is termed an outstanding loan amount. For finding home equity, the outstanding loan amount is subtracted from your home’s market value. 

Note:- With the help of examples you can get a better understanding of the same-

If your home’s current market value is Rs. 40 lacs and you still owe Rs. 20 lacs on your home loan, now you can calculate equity on your home like this:

Home Equity = Market Value – Outstanding Loan Amount

Home Equity = Rs. 40 lacs – Rs. 20 lacs = Rs. 20 lacs. 

Benefits of Home Equity Loan

While taking a home equity loan you’ll experience numerous benefits, some key benefits are as follows:

  1. Debt Consolidation- This saves money on interest, home equity loans have competitive interest rates in comparison to other loans or credit cards. This offers manageable payment with a lesser interest rate than others which simplifies finances.

  2. Lump-Sum Access- On a home equity loan, you will get a one-time lump-sum payment, which is more beneficial for major expenses such as house renovation, education, or many others.

  3. Fixed Interest Rate- Usually a fixed interest rate is offered on home equity loans, which shows the rate doesn’t change over time. It helps the applicant to manage and plan their finances in a better way.

  4. Longer Repayment Time- Home equity loans often offer longer repayment terms, which can be extended up to 15-20 years based on your loan amount. Longer terms can lower your EMI amounts, which makes it easier to manage your budget.

Difference between a Home Equity Loan and a Mortgage

There are some major differences between a home equity loan and a mortgage, which are different from each other. Some key differences are as follows:

Features

Home Equity Loan

Mortgage Loan

Definition

A loan is taken against the equity (value) of an owned property

A loan is taken to purchase a property or refinance an existing loan

Purpose

For funding large expenses like renovations, education, or medical bills

To buy or construct a new home, or refinance an existing home loan

Collateral

The existing home is used as collateral

The new home or property being purchased is used as collateral

Loan Amount

Based on the property’s current market value minus any outstanding loans

Based on the property’s purchase price or construction cost

Interest Rate

Usually fixed, but can vary

Can be fixed or floating, often linked to market rates

Repayment Tenure

Shorter term (usually 5-15 years)

Longer term (up to 30 years)

Tax Benefits

Interest payments might be eligible for tax deductions under Section 24(b)

Principal and interest payments are eligible for tax deductions under Sections 80C and 24(b)

Usage Flexibility

Can be used for any purpose

Only for home purchase, construction, or renovation

Conclusion

In concisely, we can say home equity loans are a powerful financial resource for homeowners who want to convert the value of their property for major expenses. With many advantages like competitive interest rates, fixed monthly payments, and potential tax deductions, it becomes more attractive for funding projects like home renovations, consolidating debt, or medical bills.

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