Refinancing

What you need to know about home equity

Nathan Gooley
Dec 19, 2020

Table of Contents

If you own your own home, you’ve no doubt thought about the benefits that come with being in the property market. You may have even considered accessing the equity in your home to do renovations, consolidate your debts or even to purchase an investment property.

Get a better understanding of what equity is, how it works and how you can access it so that you can make smarter decisions about your financial future.

What is home equity?

Home equity is the difference between the current market value of your property and the remaining sum of your home loan. If you've had your home loan for some time you are likely to have built up a reasonable amount of home equity through your mortgage repayments. 

To put it simply:

The current market value of your home - Your current home loan balance = Your home equity.

This would be the total equity you have built up in your home, but this may not reflect the usable equity you have access to.

How is home equity calculated?

The total equity in your home is one thing, but a lender won’t typically let you access all of this equity. You’ll only be able to access a portion or percentage of your total equity. Lenders calculate this to help lower the risk of you accessing your equity and then defaulting on your loan. A lender may allow you to access more if you are willing to pay lenders mortgage insurance (LMI).

The equity you have access to is calculated by:

Work out 80% of the current market value of your property - Your current home loan balance = Equity lenders will let you access without paying LMI.

As an example, say your property is worth $500,000 and your remaining home loan is $350,000. Your lender will take your property’s value ($500,000), work out 80% of this value ($400,000) and subtract the remaining balance of your home loan ($350,000). This calculation will offer a usable equity amount of $50,000.

How can you build equity in your home?

Now you have a better understanding of what home equity is, you'll want to work on how you can build equity in your home. There are a few simple actions you can take to build up equity in your home. These include:

  • Doing renovations. Renovating your home by upgrading your bathroom or kitchen or adding a deck will help increase the value of your property and therefore build equity.
  • Increase your home loan repayments. Making additional or larger repayments means you’ll be repaying more of the principal of your home loan and therefore building equity in your home.
  • Use an offset account. An offset account provides you with a sub-account to your home loan that works like a transactional account. The benefit of an offset account is that you can reduce your interest amount. Your loan principal gets reduced by the amount of money you hold in your offset account. By paying off more principal each month, you’ll build equity in your home.
  • Make lump-sum payments. Similar to increasing your repayments if you have some extra money and put it into your home loan, this will build equity in your home.
  • Property market changes. You can't actively change the property market. But if the property market changes in a way that increases your property’s value, it will create equity.

What are some common home equity uses?

There are multiple home equity uses that may give you a reason to look into accessing the equity in your home. If you're thinking of renovating, need to consolidate your debts or want to buy an investment property, these are all some of the uses for home equity.

Property purchase with no deposit

Adding a second property to your portfolio, either as an investment or a holiday home, is an attractive reason to access your home equity. It will help you lower the upfront costs that can come with purchasing a property. You can use any equity you have as the deposit for your new property.

Home renovation

Using your home equity to renovate your home is a great way to make your equity work for you. When you renovate by updating your kitchen or bathroom, you add value and therefore equity to your home. So by using your current home equity to do these renovations, it’s a financial investment that repays itself in the long run by also increasing the value of your home.

Debt consolidation

Since purchasing your home, you may have built up other debts like car loans, credit card debt or other personal debt or credit. You can use the equity you have built up in your home through your mortgage repayments to pay off these, usually, smaller debts.

Investments

Property is one of the ways you can build wealth and increase your financial portfolio, but there are others. You may consider using some of your home equity to diversify your investments. You could invest in the share market or in a high-interest savings account for instance. If you do want to make a move into the share market, be sure to do research. You may even seek the advice of a financial advisor to help you with the decision making process.

Other personal loan options - car purchase, holiday, etc.

You've been so good at minimising your spending to pay off your home loan. You may have skipped things like holidays for the family or that brand new car you've always wanted. You can use the equity in your home to help pay for some, if not all, of that big purchase rather than taking on an alternative form of debt like a personal loan or credit card.

How much home equity can you access?

When you access the equity in your home, you're essentially withdrawing the repayments you've made into your home loan. Lenders will therefore look at how much equity they'll allow you to access in the same way as they looked at how much they were willing to lend you in the first place.

Your lender will calculate your usable equity and will take into account your borrowing power. They do this to make sure you can service the increased loan amount. Your lender may allow you to access additional equity where the LVR exceeds 80% if you’re willing to pay lenders mortgage insurance (LMI).

What is the process of accessing home equity?

There are a few ways you can access the equity in your home, depending on what you plan on doing with the funds.

Refinancing to access home equity

The most common way borrowers access home equity is by refinancing their home loan either with the same lender or with a new lender. There are some considerations you need to make before refinancing, such as any possible upfront costs of a new home loan and the interest rate. You’ll also need to be able to meet the required home loan repayments on the increased loan size after accessing your equity. 

Refinancing is the most common option taken when using equity to buy another house, whether you’re buying an investment property or just a second home.

Redraw facility to access home equity

If you’re only wanting to access a small amount, you may be able to use a redraw facility, if you have one. A redraw facility offers you access to any additional repayments you have made into your home loan. At Yard, our home loans come with unlimited free redraws.

Line of credit loan to access home equity

If you're looking to use the equity in your home to do renovations, you may consider taking out a line of credit loan. A line of credit loan allows you to withdraw funds as you need them, rather than receiving a big lump sum and you can secure the loan against the equity in your home.

Line of credit loans often have a higher interest rate than standard loans due to the fact you're accessing the money at intervals rather than in a lump sum.

What to consider before accessing your home equity

Before you dive into accessing the equity you’ve built in your home, there are a few factors you should consider. These factors include the increased risk, the increase in debt and other details that come with accessing equity, to make sure it's right for you.

  • Increased debt - Accessing the equity in your home will increase your loan amount depending on how much you access. 
  • Increased risk - Increasing your loan amount also increases the risks that come with any sudden changes to your financial situation, which can cause you distress. 
  • Higher costs - Changing your loan amount will increase the interest you’re paying, which may also increase your monthly repayments. 
  • Extend loan term - By increasing your loan amount, you may also increase the loan term as it might take you longer to pay off the larger loan amount.

All these factors should be taken into account when you consider accessing your equity. 

You should also look at maintaining a safety net of savings to help protect you from any sudden changes to your financial circumstances. With appropriate planning and budgeting, you can minimise the risk of any financial stress occurring if you access your home equity and your circumstances change.

If you've built up home equity and want to discuss how you can access it, reach out to a Yard specialist to find out how we can help you.

Nathan is a co-founder of Yard

Want to learn more?