Whether you’re looking to shave money off the repayments on your home loan or looking for a new loan on an investment property, it’s easy to find yourself overwhelmed. Sky-high interest rates coupled with rising house prices in Australia have left many feeling the crunch. In some circumstances, homeowners may be able to use equity in their property to score a better home loan.
How much equity do I have, and how does home equity work?
Before you focus on using equity, you need to understand how much equity you have in your current home loan. The amount of equity is usually expressed as an LVR, or loan-to-value ratio.
LVR represents the value of your property as the loan balance to the amount that you have paid (aka your available equity). This is usually expressed as a percentage, and home loans are often grouped in tiers with interest rates grouped for LVR >90 or LVR<90, for example.
High LVR home loans are considered higher risk by lenders, as they require lower deposits. If you pay less than a 20% deposit in Australia, you may be required to pay lenders mortgage insurance (LMI). They may also attract higher interest rates and lending stricter criteria.
Your home equity increases as you make repayments on your home loan, chipping away at the loan amount, and can be sped up by making extra repayments if your lender allows. Your equity can also be increased in other ways, like if the value of your home increases.
Your home’s value is not locked at the price given to you on its initial property valuation. The market value of the property can increase for many reasons, including the area becoming more desirable or in the case of certain renovations. While home renovations like additions of solar energy or expansions may require larger lump sum upfront costs, they could end up being major boosters to your home’s value, which in turn can boost your usable equity. As a disclaimer, the entire value of your home is not your usable equity.
What is usable equity?
Usable equity can be calculated by working out 80% of your home’s current value (you may need an updated property valuation for this), less the amount still owing on your home.
Being able to access equity in your home may allow you to refinance to new home loans with lower interest rates (and the resulting lower loan repayments!) and more attractive features, like offset accounts. It may also come in very handy if you are looking to make a property investment, or can be used for other lifestyle expenses to ease your financial situation.
Using home equity loans to buy a second property
A home equity loan is any type of home loan that uses equity on your current home’s value to purchase a second property. There are different ways to go about buying your new property with your equity.
Before making any major decisions about a long-term financial product or refinancing, consider speaking to a financial adviser or specialist broker. You will also want to read the product disclosure statement and target market determinations for any financial product you are looking into.
Line of credit
A line of credit operates like a credit card based on the available equity you have in your home. This is calculated off of the loan balance remaining on your existing home loan and the current value of your property. If you are approved for a line of credit, you may be approved for a set amount of money borrowed against your home equity.
You can potentially use this all at once to invest in real estate, but you can also use a line of credit to finance things like renovations or lifestyle purchases.
Due to their nature, you only pay interest on lines of credit, and they are generally attached to variable interest rates. Loan repayments will vary depending on the loan term and loan amount.
Lump sums
A lump sum home equity loan works like a typical home loan, generally with a fixed rate (so make sure to check the comparison rate, which may reflect fees and additional payments).
Loan top-up or cash-out refinancing for a second home
If you have significant equity in your home, you may be able to access a supplementary loan or a loan top-up to purchase an investment property. This can help you put down a deposit on a new property without needing to pay lenders mortgage insurance, for example. You may also be able to do this via refinancing.
When you take out a mortgage for a greater value than your existing home loan and take the monetary difference, this is called cash-out refinancing. You can use this differential money as your cash deposit.
Are there any downsides to using my home equity for a property investment?
While it may always seem like a good idea to get a cheaper home loan, it’s important to stay fully informed before you make any decisions on using your access equity in your home.
This is because home equity is an asset in your favour and contributes positively to your financial situation, especially when you are applying for other financial products (like credit cards or car loans, for example). It can also be a good emergency source of funding in the case that you need money.
It’s important to be sure of how you will make your repayments if you do end up refinancing or taking out a new home loan, as any new loan product comes with serious ramifications and is a long-term commitment.
You will also have to be approved by your lender to use your home equity. Simply having a large amount of equity in your current home does not give you the ability to borrow against it, and lenders will also consider factors like your income, your age, your dependents, and any debts you have to your name.
