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Tata Capital > Blog > Loan for Home > What Is A Home Equity Loan & How Does It Work?

Loan for Home

What Is A Home Equity Loan & How Does It Work?

What Is A Home Equity Loan & How Does It Work?

Owning a home is a lifelong dream for many, symbolising stability, security, and an investment in the future. Yet, beyond its role as shelter, your home can also serve as a valuable financial asset.

This is where home equity loans come into play—a versatile financial tool enabling homeowners to tap into the equity they've built up in their property. With a home equity loan, borrowers can fund significant expenses such as home renovations, asset allocation, debt consolidation, or other significant costs.

In this article, we'll delve into what a home equity loan is, its various types, benefits, and how it operates.

What is a home equity loan?

A home equity loan is a financial tool that enables homeowners to borrow against the equity they've built in their property. This equity represents the difference between the current market value of the home and the outstanding mortgage balance. Similar to a second mortgage, this loan uses the property as collateral for additional borrowing.

Types of home equity loans

There are two types of home equity loans:

Fixed-rate home equity loans

Fixed-rate home equity loans provide customers with a lump sum of money that must be repaid to the lending bank along with interest. Unlike other loans, the interest rate for fixed-rate home equity loans remains constant throughout the loan's duration, unaffected by market fluctuations.

Home equity line of credit (HELOC)

HELOC provides access to revolving credit, similar to a credit card. With a HELOC, you are approved for a total credit line amount based on the equity in your home, but you do not receive the total amount upfront in a lump sum. Instead, you can withdraw money from the HELOC as needed, up to the approved credit limit.

The lender determines the duration of the draw period, allowing you to access the funds. Unlike fixed-rate home equity loans, HELOCs feature variable interest rates that vary according to an index such as the prime rate. Throughout the draw period, you're only required to pay interest on the borrowed amount.

Upon the draw period's conclusion, you transition into the repayment phase, where you make monthly payments covering both the principal balance and accrued interest until the HELOC is fully repaid.

How does a home equity loan work?

A home equity loan operates akin to a conventional home loan, utilizing the property as collateral. However, unlike a typical home loan that provides a set amount for property acquisition, a home equity loan lets you to tap into the equity accumulated in your home, converting it into liquid funds.

Here's a breakdown of how a home equity loan is calculated:

Let's consider a scenario where you've purchased a house valued at Rs. 70 lakhs and have taken out a loan of Rs. 60 lakhs. In this case, the equity in your home would be Rs. 10 lakhs, calculated as follows:

Equity = Value of the house (Rs. 70,00,000) - Total loan amount (Rs. 60,00,000) = Rs. 10,00,000

Now, let's fast forward a few years. Assume that the value of your house has appreciated to Rs. 90 lakhs, and you've paid off half of your original loan amount. With only Rs. 30 lakhs left to repay, your equity in the house increases. The new equity calculation would be as follows:

Equity = Current value of the house (Rs. 90,00,000) - Remaining loan amount (Rs. 30,00,000) = Rs. 60,00,000

The equity in your home fluctuates over time, influenced by changes in property value and outstanding loan balances. It's essential to understand that while equity can increase, it can also decrease, especially during significant downturns in the real estate market, which impact property values in your area.

Benefits of a home equity loan

Home equity financing offers homeowners a flexible way to leverage their property's equity for diverse financial needs. Let's explore some common scenarios where you can effectively utilise this valuable financial tool.

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1. Debt consolidation: Many homeowners use home equity loans to consolidate high-interest debt, such as credit card balances, into a single, more manageable payment with a lower interest rate. This can help save money on interest and simplify finances.

2. Funding major expenses: Whether it's financing a child's education, covering medical expenses, or funding a once-in-a-lifetime vacation, a home equity loan can provide the necessary funds. Since the loan is secured by your home, lenders often offer more favourable terms compared to unsecured loans.

3. Home improvement: From kitchen renovations to backyard makeovers, investing in home improvements can enhance your quality of life and increase the value of your property. A home equity loan provides a convenient way to fund these projects without depleting your savings or resorting to higher-interest financing options.

4. Investment opportunities: Homeowners with equity in their property may choose to leverage it to invest in other opportunities. You can use funds to start a new business, expand an existing one or even buy a piece of new equipment or machinery for the business. With this loan, you can cover your business financial needs with ease.

It's important to carefully consider your financial situation, objectives, and risks before utilising a home equity loan for any purpose. Additionally, ensure that you have a repayment plan in place to manage the borrowed funds responsibly.

The bottom line

A home equity loan presents a valuable financial opportunity for homeowners seeking to utilise the equity tied up in their property. Whether the goal is debt consolidation, financing significant expenses, or undertaking home improvements, this option offers a flexible and cost-effective solution.

If you require immediate access to funds, consider opting for a loan on property. At Tata Capital, we provide loans with substantial amounts ranging from Rs. 5 lakhs to Rs. 5 crores, featuring competitive loans against property interest rates and minimal documentation requirements. The best part? Right from filling out the loan application to uploading the required documents, you can do it online from the comfort of your home.

Visit the Tata Capital website or download the Tata Capital App to use our user-friendly loan against property EMI calculator and estimate your potential EMIs effortlessly.

The details mentioned in this blog may change from time to time and from vendor to vendor or government policies.

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