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