What is a Home Equity Loan?

01 Oct 2020

The prices of homes are rising and if you have owned a home for long, it’s time to cash in your asset. You can do so by home equity loan. It is also known as an equity loan or second mortgage and is a type of consumer debt. With this, the homeowners can borrow against their equity in residence.

Two Types of Home-Equity Loans:

1.    Fixed rate loans

2.    Line of Credit

Tenure of these loans may vary from 5 to 15 years. Another important point to note about both the loans is that the borrower needs to pay in full if the home on which they have equity loan gets sold.

Elaboration of the two types:

Fixed-Rate Loans- If one opts for this type of loan, then one gets a lump-sum payment which one has to repay over a fixed period of time on the decided interest rate. The interest rate remains the same during the tenure.

Home-Equity Lines of Credit or HELOC- You can say that it is similar to a credit card when it comes to its functioning. Similar to a credit card, in HELOC, the borrower is eligible for a certain pre-approved amount, and he/she can withdraw the money when needed through cheques or credit card. Unlike the fixed interest rate equity loan, the monthly payment may vary. HELOC also comes with a fixed term, when the term is reached, the outstanding loan amount must be repaid in full. 

This time period may be of 10 years. It is also called a draw period.

Home Equity Loan Interest Rates

 Well, the loan rates may vary from one bank to another, The USE Bank offers an affordable fixed interest rate. The current rate is 5.49% APT if your loan tenure is ten years and 5.74% if the loan tenure is 15 years.

How do I calculate my home equity?

Well, estimating your home equity amount is not that difficult, there are many online home equity calculators that will only ask you to feed the data, and it will do all the calculations. Alternatively, this amount is decided by the LTV ratio or the Loan-to-value ratio which is decided by total mortgage debt (included second mortgage or home equity) and dividing it by the evaluated value of the house.

Uses of Home Equity Loan

One can use this loan amount for the following purposes:

  • Refurnishing and renovation of the house
  • Roof repair
  • Starting a business
  • Paying off debt
  • Repayment of college fees
  • Medical bills

The Right Way to Use Home Equity Loans

You might get the home equity loan, but it would be better if you analyze the pros and cons of the same. It’s a good tool but only for responsible borrowers. If you have a recurring income and you know that you would be able to pay it back, only then go for this loan. Remember, non-payment of the loan may affect your credit rating.

Fixed-rate home-equity loans are good to cover up the cost of a single purchase, for roof replacement whereas HELOC is good to cover short term, recurring expense.  So, make sure that you analyze the pros and cons, your requirement and ability to repay before you head for this loan.

An important point to remember here is that if you have to choose between repaying your home equity loan or credit card bill, then go for a home equity loan, because losing on it may make you lose your home too.

Drawbacks of Home Equity Loans

Well, it might seem alluring to use your home as an ATM machine which can fetch you good amount but having said that you must know that in case you fail to repay the home equity loan, the bank has complete authority to foreclose your house. It means non-repayment may make you lose your house. It is always advisable that you must consider this aspect before you apply for a home equity loan.

Conclusion- If you have decided to go ahead with the home equity loan, and are looking for the right option, then you must never make a hurry. Make sure that you do a comparison of the different interest rates provided by various banks and then make a decision. The current interest rate charged by the US banks ranges between 5.49%-5.74%. Make sure that you consider other options as well before opting for home equity loan without proper analysis of your finances.