As a homeowner, there’s nothing better than watching your nest egg grow. Having equity can open different opportunities and benefits, especially when it comes to refinancing your home loan.
What is home equity?
Your home equity is the proportion of your home that you own outright. Overtime, the equity in your home is likely to increase due to several factors, including:
- Making regular repayments towards the principal, or the amount outstanding, of your home loan,
- Undertaking renovations or improvements to increase the value of your home, and
- Improvements in the property market leading to an increase in property value.
How do I work out my home equity?
If you’re keen to work out how much equity you currently have tied up in your home, all it takes is one simple calculation. Simply minus the amount owing on your mortgage from the current market value of your property, and you’ll be left with the equity.
For example, if your home is currently valued at $700,000 and you still have $400,000 outstanding on your home loan, you have $300,000 of equity. But just because you have $300,000 of equity in your home doesn’t mean you have access to all of it. That’s where usable equity comes in.
What is usable equity?
Most banks will only lend up to 80% of a property’s market value. Once you take away the amount still owing on your loan, you should be left with your usable equity.
Based on the figures above, 80% of the current market value of your $700,000 home is $560,000. If you still owe $400,000, you actually have $160,000 of usable equity.
Why is equity important for refinancing?
Your home equity plays a key role if and when it comes time to refinance. The more equity you have in your property, the lower your loan to value ratio (LVR).
How to tap into your home equity
While equity is an important factor that lenders consider during the refinancing process, there are several ways to access your home equity without refinancing your existing home loan.
One of the main ways to access your equity without refinancing is by taking out a home equity loan, also known as a a second mortgage. A home equity loan is a type of mortgage that allows you to borrow against your home equity.
Here are the two basic types of home equity loans to familiarise yourself with.
Line of credit
A line of credit works in a similar way to a credit card. Borrowers are approved to reborrow funds up to a pre-defined limit, if and when they need access to the funds. Your mortgage repayments will be adjusted based on the amount you’ve borrowed through your line of credit, meaning that you’ll only be charged interest on the amount that you borrow.
A lump sum is similar to a personal loan, car loan or mortgage. This type of home equity loan uses your equity as security to borrow a large sum of money. Like other types of loans, you’ll pay back the borrowed amount over time with the addition of interest, at either a fixed or variable rate.
Another type of home equity loan is the reverse mortgage - however, this type of mortgage is only usually available to retirees. A reverse mortgage allows the homeowner to release a portion of their equity as a lump sum, line of credit or as regular repayments. This can provide retirees with cash to support their living expenses. Reverse mortgages often attract higher interest rates than standard mortgages. While the homeowner doesn’t have to make repayments while they’re living in the property, when they move or sell the loan amount must be repaid in full with interest.
What can I use my home equity loan for?
Homeowners take out home equity loans for all sorts of reasons, including:
- Buying an investment property: Rather than trying to save on top of repaying your existing mortgage, a home equity loan can provide the funds needed for a down payment on an investment property.
- Funding renovations: Many people build up equity in their homes to pay for future improvements and renovations. A home equity loan can allow you to tap into these funds to carry out your renovations and, in turn, increase the value of your home.
- Supporting other big-ticket purchases: Your home equity can also be used to fund other big purchases, like a new car, establishing a business or supporting your child’s education.
- Paying off other debt: If you have other debt, like a personal loan or credit card debt, that’s being charged at a higher interest rate than your home loan, you can free up your equity to pay off these debts.
Learn more about the refinancing process and whether it’s right for you here.
This article does not have regard for the financial situation or needs of any reader and must not be relied upon as financial product advice. As this information has been prepared without considering your objectives, financial situation or needs, you should, before acting on this, consider the appropriateness to your circumstances.