A home is a single property, but it offers many benefits. Over time, its value increases, making it a useful financial tool during difficult times. Wondering how?
This Brick & Bolt blog has all the answers. Keep reading to learn more and choose the right loan option between a Home Equity Loan and a Home Equity Line of Credit (HELOC).
What is Home Equity?
Before taking any loan above your home, you need to understand your home equity. Home equity is the difference between a house property’s current market value and any liens, such as a mortgage, that are attached to that property.
How Home Equity Works:
- When you purchase a home with a mortgage, the lender holds a portion of the property until the loan is fully repaid. After the full payment of the loan, you will completely own the property.
- Eventually, when you make mortgage payments, the loan balance will be reduced by equity increases.
What is a Home Equity Loan?
A home equity loan, commonly called a second mortgage, is a loan taken on your home. Typically, lenders will allow you to take up to 80% of the equity that you have put into your home. You will also receive a lump sum of money with a home equity loan. Generally, these loans come with a fixed interest rate and have a term of 5, 10, or 15 years. Your interest rate will depend partly on your credit scores, which are taken from information on your credit reports.
After receiving the lump sum amount, you must pay back the loan and interest within the period outlined in the loan contract. Generally, home equity loan payments are set and paid monthly. If you miss your loan payments or cannot pay off the debt, the lender may take ownership of your property via a legal process called foreclosure. If faced with foreclosure, you may be compelled to sell your home to pay off the remaining debt.
Home equity loans are commonly taken for financing home renovations, handling medical emergencies, or covering other large expenses.
What is a Home Equity Line of Credit (HELOC)?
In HELOC financing, homeowners apply for a revolving credit line with a fixed borrowing limit. They can withdraw funds as needed within a pre-approved limit and only pay interest on the amount they use.
A Home Equity Line of Credit (HELOC) typically stays open for 5 to 10 years, during which you can borrow money as needed. This phase is called the “draw period.”
Once this period ends, the HELOC enters the repayment phase, which usually lasts up to 20 years. During this time, you can no longer borrow more money and must start repaying the amount you used. The repayment is made through fixed monthly payments until the full loan amount is paid off.
Home Equity Loan Vs HELOC
You need to understand the major differences between Home Equity Loan and Home Equity Line of Credit (HELOC) before deciding.
| Home Equity Loan | Home Equity Line of Credit (HELOC) | |
| Structure | Gives a one-time lump-sum payment depending on the home equity. | Similar to a credit card, it offers revolving credit, allowing homeowners to take funds as needed up to a pre-approved limit. |
| Interest Rates | The interest rate stays the same for the whole loan period. This means your monthly payments will not change. | The interest rate can change depending on the market. This means your monthly payments may go up or down over time. |
| Repayment | Repayments will be fixed Equated Monthly Installments (EMIs) for the duration of the loan, easing budgeting concerns. | It allows borrowers to make small payments at first by paying only the interest. Later, they can start paying both the loan amount and interest. |
| Usage | It is suitable for one-time large expenses like home renovations or major purchases. | Suitable for ongoing costs, like business needs, because you can keep using the money when needed. |
Eligibility Criteria for Home Equity Loans and HELOC in India
To take out home loans, either through Home Equity Loans, Home Equity Lines of Credit (HELOCs), or both in India, you need to meet the following eligibility criteria:
Home Equity
You should have a minimum of 15%-20% equity on your property. A professional appraiser will decide on your home equity before approving the loan based on market value.
Credit Score
You should have a credit score of 620 or more, which is typically required, with scores exceeding 700 to secure better terms.
Income Stability
You should have a stable and verifiable income. Lenders will assess your income and a debt-to-income (DTI) ratio below 43%-50%.
Documentation
You will need to have ready documents, including proof of income, property ownership, and ID proof.
Loan-to-Value (LTV) Ratio
Typically, borrowers can get a loan amount of 80%-85% of their home equity.
Property Valuation
You should conduct a proper property valuation to determine the home’s current market value.
Interest Rates and Fees for Home Equity Loans and HELOC in India
Usually, interest rates of home equity loans and Home Equity Lines of Credit (HELOC) in India range from 8% to 12% per year.
Along with interest rates, you need to consider various fees associated with these loans as follows:
- Processing fees will commonly take around 0.5% to 2% of the loan amount.
- Valuation charges for assessing the property’s worth.
- Sometimes, lenders can impose prepayment penalties if the loan is repaid before a specified period, which will impact overall costs.
Pros and Cons of Home Equity Loans and HELOC
Before deciding on either loan option, you need to understand their advantages and disadvantages.
Home Equity Loan Advantages
- You will get the complete loan amount at once.
- The interest rate will be fixed.
- You can predict the total amount that you need to pay later, which helps you prepare in advance.
Home Equity Loan Disadvantages
- You can’t get an extra loan without applying for a new loan or refinancing.
- The initial payment amounts will be larger because the principal and interest payments were kept due from the start.
HELOCs Advantages
- You will have the flexibility to take out a loan whenever needed, irrespective of the amount.
- The initial payments will be less compared to a home equity loan because you have to pay the interest during the draw period.
- The credit will vary based on the amount you take. You can easily borrow, repay, and borrow again for ongoing credit access.
Cons of HELOCs
- In case interest rates increase, you have to pay an unexpected amount.
- Your monthly payments can fluctuate, causing fluctuations in interest rates.
- This easy access can lead to overspending, presenting a financial risk if not managed carefully.
Tax Benefits of Home Equity Loans and HELOC in India
In India, you can get tax benefits on both home equity loans and HELOCs based on Section 24(b) of the Income Tax Act. You can get concessions with claim deductions on interest payments for property loans. You must ensure the loan is spent on purchasing, constructing, or improving property to benefit from these deductions.
On a final note, you are entitled to take any loan against property in India. Home loans are the most common ones. You can use your home’s equity to get both home equity loans and HELOCs. But consider your requirements carefully. Weigh both the benefits and drawbacks of each based on your finances, borrowing plans, and comfort with risk.
Hemali Patel