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For many Australians, the family home is their biggest asset. But when it comes to equity, there’s often confusion. You might hear you’ve “got equity” and assume you can use all of it. The reality is, lenders look at it differently.
What is Home Equity?
In simple terms, home equity is the portion of your property that you truly own.
It’s calculated by taking the current market value of your property and subtracting the outstanding balance of your home loan.
Property Value – Loan Balance = Total Equity
For example, if your home is valued at $800,000 and you owe $450,000 on your mortgage, your total equity is $350,000. It’s a straightforward calculation.
However, it’s crucial to remember that your total equity is not always the same as the amount of money you can access or borrow against. This is where lenders introduce other factors.
The Role of Loan-to-Value Ratio (LVR)
One of the most important metrics for any lender is the LVR. This ratio compares the amount of your loan to the value of your property, expressed as a percentage.
LVR = (Loan Amount ÷ Property Value) x 100.
Lenders use LVR to assess the risk associated with a loan.
A lower LVR means you have more equity in your property, which makes you a less risky borrower. Most lenders are comfortable with an LVR of 80% or less.
It’s important to note that these are general lender practices. The specific policies and LVR thresholds can vary between different banks and financial institutions.
How Lenders Calculate Usable Equity
There is a crucial distinction to be made between your total equity and what lenders call “usable equity” or “accessible equity.” Usable equity is the amount a lender will allow you to borrow against.
Lenders typically cap the total loan amount at 80% of the property’s value. Therefore, your usable equity is the difference between this 80% LVR limit and your current loan balance.
Using the earlier example, if your home is valued at $800,000 and your mortgage is $450,000. Here’s the breakdown of sums:
- Value of your property: $800,000
- Value of your property at 80%: $640,000
- Minus your mortgage: $450,000
This means your usable equity is $190,000.
In this example, even though you have $350,000 in total equity, you would generally only be able to access $190,000 without needing to pay LMI.
What influences a Lender’s Assessment?
Calculating usable equity involves more than just a simple formula. Lenders consider several factors when assessing an application to release equity.
- Property Valuation Methods: The “V” or “value” in LVR is determined by a formal property valuation, not a real estate agent’s appraisal. The method used can impact the final figure.
- Loan Type: Lenders may have different criteria for owner-occupied properties versus investment properties. They often view investment loans as having a slightly higher risk profile.
- Your Borrower Profile: Your financial situation is key. Lenders will assess your income stability, credit history, and existing financial commitments (like car loans or credit cards) to ensure you can comfortably service the increased loan amount.
- Market Conditions: In times of economic uncertainty or a falling property market, lenders may become more conservative. They might reduce their maximum LVR or apply stricter assessment criteria to mitigate their risk.
General Tips for Borrowers
If you’re thinking about using your home equity, here are a few tips to help you prepare:
- Keep your property well-maintained: A tidy, well-cared-for home can positively influence a full valuation.
- Regularly review your loan: As you pay down your loan and property values change, your equity position shifts. Staying informed helps you know where you stand.
- Talk to a mortgage broker: Every lender is different. A broker can compare policies from various lenders to find a solution that fits your needs and helps you understand the nuances of their assessment criteria.
Home equity is an important financial tool, but lenders assess it carefully based on LVR, property valuations, and your personal financial profile. Understanding these factors helps you approach the process with confidence and clarity.
If you’re curious about how much usable equity you might have and how you could use it to achieve your goals, the next step is to get personalised guidance.
Speak with our local expert mortgage brokers today for a clear picture tailored to your situation. We’re here to help.
