Definition
Home Equity Loan
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A home equity loan is a term loan secured against property in which the borrower receives a lump sum in cash.
The property is used as collateral to the bank and the borrower gets access to the cash loan.
This is a very useful method for homeowners to get access to funds when they have unencumbered property and want to get a loan at low interest rates.
The key difference between a home equity loan and a typical home loans is that funds from the latter can only be used to pay a home seller or developer. Funds from the former can be used for any purpose the borrower intends as he gets access to it in the form of cash.
Another difference in the Singapore market is that regular home loans offered by banks can be used for public housing (HDB) transactions, while home equity loans are only available for private property.
Saying that, it does not mean that a private property would be entitled to home equity term loans as every mortgagor (borrower) would still have to be put through the credit screening and assessment process.
When there is an existing loan on a house, borrowers can often consider equity loans via a cash out.
Difference between cash out and home equity loan
Sometimes a cash out refinancing is deemed as a home equity loan. But by definition and practice, they are not the same.
A cash out refi consist of a new home loan with a larger loan quantum than the current one. This new and bigger loan would fully repay (or replace) the existing housing loan, with the remaining balance as free funds for the borrower to use in cash.
Because of the similarity of this balance and an actual home equity loan, the terms used to describe them are often used interchangeably.
But as one can see from reasons explained above, they are not the same.
It should also not be confused with a HELOC.
How it works
When a home equity loan is approved, the funds would either be presented to the borrower via a cheque or disbursed into an account which the lender has opened for the borrower.
The borrower can then either cash in the cheque into his own personal accounts, or access the funds with a credit card, cheque book, or ATM card when a account has been opened specifically for the borrower.
This account can sometimes even be interest-bearing which is bank’s way of encouraging the borrower to keep the money in the account instead of using it.
The equity loan acts like a typical mortgage with amortization properly scheduled for the entire life of the term loan.
Borrowers would make payment just like a typical home loan.
The interest rate charged will depend on whether it is on a fixed rate or a floating rate pegged to an index rate.
They are typically the same types of interest rates of regular housing loans offered by the same lender.
For example, if a lender is offering SIBOR + 1% for their regular housing loans, then this rate should be available for their home equity loans as well.
Closing costs
The costs that a borrower can expect to pay might include:
- Redemption penalty charged by existing lender
- Other penalties by existing lender such as legal clawback
- Legal fees
- Facility fee
- Valuation fee
- Administrative fee
- Other junk fees
When considering whether to accept a home equity loan, don’t forget to ask for fee waivers or freebies.
If you don’t ask, you’ll not get them. And if you ask, you might just get lucky.
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