Homeowners have a unique real estate trick up their sleeves that can help them afford life’s biggest investments, from paying a cash deposit on a second property to refinancing a home loan for better interest rates.
The trick? Eligible borrowers can use their home equity to unlock a new source of funds, all from the value of their current property.
So what is home equity? And how can you use equity in Australia as a home loan deposit?
What is home equity?
Home equity is the value of your financial interest in your home. It takes the current value of your home and subtracts any debt obligations you have against it, such as a home loan.
An easy way to think of equity is with this formula:
- Equity = market value - loan balance
Home equity is different from your loan-to-value ratio, or LVR, which is the loan amount you’ve borrowed divided by the total value of the property.
- LVR = loan balance/market value
Essentially, your LVR is the percentage of your property that you own, while your home equity is how much your ownership is worth. Use our loan-to-value ratio calculator to calculate your LVR.
An upfront home loan deposit helps establish your home equity and LVR by giving you an initial stake in your property. For instance, if you pay a 20% deposit, you have 20% in home equity and an 80% LVR.
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Why is it a good idea to use your home equity?
The home equity in your existing property can be incredibly useful, particularly if you’re interested in buying a new home, second home, or investment property.
This is because financial institutions view your home equity as an asset in your property portfolio, making it a clever source of funds. Useable equity can be unlocked to:
- Buy a new property with no deposit.
- Refinance your equity property to better home loan rates.
- Make a property investment.
Using one asset to finance another is also called cross-collateralisation.
How much equity can you use?
Typically, lenders will let you unlock up to 80% of the market value of your property, minus any debts, as useable equity.
So if your current property is worth $500,000, and you have $200,000 left on your loan balance, you can access 80% of $500,000 - $200,000 ($240,000). This is a sizeable chunk of money and could cover the deposit needed for a new loan.
Can I used a gifted home deposit?
How much equity do you have?
To determine the amount of equity you have, you will need to know the value of your property and how much you’ve spent on home loan repayments.
Your property value might not be immediately obvious, but there are some ways to zero in on a number. This can include knowing:
- The purchase price.
- The results of a recent property valuation.
- Capital growth values in your area.
All of these numbers can tell you how much equity you have — and therefore, how much useable equity you have. You can seek professional advice from a mortgage broker, financial adviser, and property valuator to see what available equity you may have against your current home loan.
How to access equity for a property investment
To access your equity, you must refinance your home loan, i.e. move your mortgage to a new lender. This releases the available equity to you.
You will need to know the value of your home, as well as your LVR and anything that could impact your line of credit, such as your credit score and debt-to-income ratio.
It’s also important to consider whether you can finance two home loans simultaneously. You may have $200,000 in available equity, but if you can only reasonably afford $100,000 in additional loan repayments, a responsible lender will limit your useable equity to $100,000.
Once you have the paperwork in order and you know how much equity you have, it’s time to get stuck into it.
- Compare home loans carefully, including any interest rates, fees, and features, to find the best deal for you. You can check the terms and conditions of a home loan in the product disclosure statement (PDS).
- Lodge your equity loan application with your desired lender to refinance your mortgage and unlock your equity. You must showcase that you own 20% of your current property, have a clean repayment history, and have enough income to service multiple loans.
- Settle your successful application, which usually takes between six to eight weeks. The timing may vary depending on the lender, contract paperwork, and approval process.
This process is highly simplified, of course. Making your equity work for you requires careful research and calculations since there are other home loan costs such as stamp duty to budget for. Talk to a financial adviser to see if this move could work best for you.
TIP: Keep in mind if you don’t have enough equity for a new 20% deposit, you may have to pay lenders mortgage insurance (LMI) on your second property, which can ratchet up the cost of your future loan repayments.
How do I gift my child a home deposit?
How do you increase your home equity?
There are a few ways to increase your home equity if you don’t have enough equity. Some of it may happen automatically for you in the form of capital growth: home values tend to rise over time, and as values rise, so does your available equity.
It all goes back to the home equity equation:
- Equity = market value - loan balance
If the market value goes up or the loan balance goes down, your equity increases.
The most active way home buyers can improve their equity is to pay off their home loan. You can do this by making extra repayments if this option is available on your home loan.
For example, you could put the extra cash you saved through offset accounts or switch home loan interest rates into making a few additional repayments for the year. This reduces the size of your loan, then voilá: more equity.
You could also boost the market value of your home through renovations, repairs, and home improvements, such as installing solar panels. How much this affects your property value, however, will vary based on the surrounding suburb and your individual property.
Depending on your financial situation, the money you spend on refreshing your existing property might be better spent refinancing or making extra loan repayments.
Consult a financial adviser to get across what might work best for you.
