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Home Equity
So you’ve purchased your home and have been working hard at paying your loan off. It’s going well and you are feeling financially stable. What’s the next step?
You don’t have to wait till you’ve paid out the entire loan, there’s plenty you can do to get moving towards bigger and better financial goals.
Using your home equity is one pathway forward. As Mark Bouris said recently, “By repaying your mortgage and hopefully experiencing moderate capital growth in your property, you build equity – the value of the property minus what is owed.”
With the right mortgage product (otherwise known as a ‘home loan’), this equity can be ‘drawn down’ for emergency finance, or it can be used as security on other loans. Equity can be controlled: many households repay more than the minimum amount to further grow their equity.
Let’s take a look at how the balance of your home loan can be leveraged to your advantage when it comes to property investment.
What is equity?
Equity is the difference between the value of your house and your current debt. Equity can build up over time, as you make repayments on your loan or as the value of your house increases.
For example, if your property is valued at $700,000 and you have a loan of $400,000 then generally speaking, your equity is $300,000.
Lenders typically use about 80% of the value of your home to calculate what they would consider usable equity. Let’s look at a general calculation.
Keeping in mind exit costs and other considerations, this would mean that your usable equity would come in at around $160,000 if we do the following calculation:
80 % of $700,000 is $560,000
$560,000 minus $400,000 (your loan amount) = $160,000 of usable equity.
That’s a fair chunk of money to invest towards your financial goals!
But how does it work?
We can’t give you complete guidance on how your equity situation would play out, as every lender is going to tailor your options to your situation. This means the amount of equity they are prepared to make available to you is going to vary considerably due to your personal situation.
Be aware that your initial useable equity is merely the amount above the minimum planned repayments.
To access the full equity amount in your property you will need to transact – i.e. restructure your loan, refinance or sell the property.
Generally, as a good rule of thumb, if you transact you can look to invest using the ‘rule of four’ – that’s 4 x your usable equity – e.g. $160,000 x 4 = $640,000.
Let’s take a closer look at the maths using the above example of a $700,000 property still owing $400,000.
Not interested in math right now? Click here to read on.
What can I use my home equity for?
Home equity can be used for a variety of financial goals including:
- Property Investment – If you’re looking to invest in property, using a portion of your equity frees up cash flow, allowing you to avoid the time to save for a deposit.
- Property Renovation or Moving House – Life changes, and so do our property needs and financial goals. Renovation can add value to your property, or make it more suitable to your new circumstances.
- Investment Portfolios – This allows you to put your equity to work. It can be through property investment or another investment strategy including shares, bonds, or managed funds.
Home equity can also be used to access funds for other, larger financial situations that may arise, depending on your specific needs.
How do I get access to home equity?
Once you’ve determined that using your home equity will help you meet your financial goals, there are usually 5 steps to accessing that equity:
- Calculate home equity
- Calculate usable home equity
- Review your loan options
- Work out the associated costs
- Apply for and settle on your chosen loan
A lender will usually require a formal bank valuation of your home to determine its current market value and your usable equity.
They will also consider several other factors including:
- your income
- your age
- how many kids you have
- any other debts
How to build your home’s equity
Reduce your loan debt – the less you owe on your home loan, the more equity you’ll have, so it makes sense to reduce the amount you owe your lender.
Improve your property – capital growth may improve the value of your property over time, but quilty renovations may increase the value of your property further or faster.
Sounds great! Is there a catch?
No catch, but as with any financial decision, there’s an element of risk.
Home equity can be a great financial tool for that next step, but do keep in mind that you are using your house as security. Therefore, it’s risky. If you default on your loan, you may lose one or multiple assets.
There will be costs associated with your investments and there are also tax implications that you should fully consider.
Navigating the complexities of equity, particularly in financial terms, can indeed be challenging when attempted alone. Be careful to seek clarity on all the options and the details of your new loan – some options out there will definitely cost you a lot more than others over the course of the loan and, importantly, you need to know you and your lender’s rights and responsibilities when it comes to servicing the loan before you agree to it.
This is where it pays to speak to a mortgage broker. Whilst a mortgage broker can’t provide financial advice, they can empower you with the expert knowledge to make an informed choice.
With a broker, they can do the research for you on making sure to match you with a lender that maximises your goals as there are a lot of ways to use your equity, depending on your specific needs and wants.
A great starting point is to identify your financial goals and seek financial advice before deciding which equity strategy will work for you.
Always speak to your financial advisor or broker for support.
Disclaimer: The information is for general information purposes only. It is not intended as legal, financial or investment advice and should not be construed or relied on as such. Before making any commitment of a legal or financial nature you should seek advice from a qualified and registered legal practitioner or financial or investment adviser. No material contained herein should be construed or relied upon as providing recommendations in relation to any legal or financial product.
