What Are Home Equity Loans And How Do They Work

Homeowners looking to tap into the value of their property are increasingly exploring home equity loans, an accessible borrowing option that turns real estate ownership into immediate funds. Often referred to as a “second mortgage” or “equity loan,” this type of loan allows property owners to borrow against the current market value of their residential or non-residential property.

These loans are categorised under consumer debt and offers flexibility in use, whether for personal needs like tuition fees, medical bills, and so on.

What is a home equity loan

Home equity loans let borrowers tap a lump sum, based on the amount of equity they have in the home.

Home equity can be calculated as:

Equity = Current Market Value of Property – Outstanding Mortgage Balance

Borrowers generally must have excellent credit and the loan-to-value (LTV) and combined loan-to-value (CLTV) ratios acceptable to the lender for approval. However, even borrowers with credit scores of 600 might be able to get approval, and they will find that their approval is much more likely to be approved than if they were applying for an unsecured loan, since the home serves as collateral in a home equity loan.

How a Home Equity Loan Differs From Home Loan

Unlike a standard home loan, where up to 90 per cent of a property’s market value can be borrowed for the purpose of purchase, a home equity loan turns existing ownership into liquidity. Both types use the home as collateral, but a home equity loan monetises the value you’ve already accumulated.

Benefits and Drawbacks of a Home Equity Loan

Here are the advantages and disadvantages of a home equity loan

1] Advantages:

§  Easier approval due to asset-backed security

§  Useful for major one-time expenses

§  Fixed rate of interest on some options aid in planning

§  Unlocks otherwise idle value from the property

2] Disadvantages:

§  Risk of foreclosure if repayments are missed. You risk losing your property in case of default

§  No tax benefits, unlike traditional home loans

§  Market fluctuations may affect equity

Although home equity loans provide a great source of low-interest financing for homeowners, taking on such debt is also an enormous responsibility. You will be putting your house on the line. Therefore, it is advisable that you do your due diligence, be clear about the terms and conditions before taking such a loan.