Your home equity is the difference between your property's market value and the balance of your mortgage. If you've owned your home for a few years, there's a good chance you've built up some reasonable equity, and this can be a valuable resource when it comes to property investment.
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Equity explained by our home loan expertRefinancing is often a tactic used to free up the equity you have in your current home in order to fund purchases or lifestyle goals.
Our home loan expert explains the term 'home equity' and how it can be accessed, and outlines ways in which it may be used.
Home equity can build up over time
One of the great aspects of home equity is that it tends to increase over time - often without any effort on behalf of the home owner. A well chosen property should rise in value over the long term, and by steadily paying off your loan, the value of your mortgage decreases. The growing gap between the two – the property’s value and the loan, represents the ongoing increase in your home equity.
Accessing home equity
Not so long ago the only way home owners could access their home equity was by selling up and upgrading to another property.
These days, mortgages are very flexible, and it’s possible to make use of home equity without the need to sell a much-loved home. It’s often achieved by refinancing your current home loan and using the funds provided from the newly enlarged loan to achieve a range of personal goals.
A flexible range of uses
As a guide, home equity can be used as a source of low cost funding for a new car, home improvements, a special holiday – in fact just about whatever purpose you choose. As home loan interest rates are generally much cheaper than other types of credit, like a personal loan, home equity can offer a very affordable source of funding.
It’s also possible to use home equity to grow your wealth. Some home owners for instance choose to use their equity as a deposit on a rental property. This expands your property ownership and provides a source of rental income, which can be used to pay off the loan.
Work out your home equity using this formula:
Property's market value - Remaining loan balance = Your home equity
For example, if your home is worth $700,000 and there is $300,000 remaining on your home loan, you have home equity worth $400,000.
However, bear in mind that not all of this will be accessible, with lenders only allowing you to borrow 80% of the property's value without being charged for Lender's Mortgage Insurance (LMI).
In other word, to avoid paying LMI, keep your Loan to Valuation Ratio (LVR) below 80%. In this given example, that means:
- 80% of the property's market value = $560,000 (this is the maximum you can borrow without incurring LMI)
- Remaining balance on loan = $300,000 (this is the amount you have already borrowed)
- $560,000 - $300,000 = $260,000
So in this example, the amount of equity you can access without incurring LMI would be $260,000.
Remember, even if you have already paid LMI before, you would still need to pay it again if you try to access equity that exceeds 80% LVR.
Here's how it works. Let's say you want to buy an investment property with a market value of $400,000. There are also additional purchase costs (legal fees, stamp duty and so on) of $20,000, bringing the total cost to $420,000.
Assuming that you meet the loan approval requirements, a lender will fund 80% of the property’s market value - potentially more if you're prepared to pay Lenders Mortgage Insurance (LMI). That is, the bank will lend you $320,000 to buy the investment property. As the total cost of the property is $420,000 you still need an additional $100,000 for the deposit and other upfront expenses. This can come from the equity in your existing home.
Let's say the market value of your existing home is $500,000 and the balance of your mortgage is $300,000. The difference between the two is $200,000, which is your home equity.
As an investor you can access up to 80% of your home equity (without the need to take out LMI), which equates to $160,000 in this example. Instead of coming up with a cash deposit for the additional $100,000 needed to buy the investment property, you can take this from the $160,000 of accessible equity in your existing home.
The available equity in your home is calculated at 80% of your home (without the need to take out LMI) less any current loans, which equates to $400,000 less $300,000 = $100,000.
Alternatively some lenders will lend up to 95% of the property value less the existing mortgage, where LMI would be paid on the amount borrowed over 80%.
We can help with accessing your equity, every step of the way.
Unlocking equity to investIf you’ve owned your home for a few years, there’s a good chance you’ve built up some reasonable equity, and this can be a valuable resource when it comes to property investment.
We can help you to find out how much equity you have in your home, and how you might be able to use it to own an investment property sooner. Watch this quick video to find out more.
Important things to consider when using equity to invest
Many property investment gurus say it’s important to repay the loan on your home as soon as you can. The equity that is drawn down from your home to purchase an investment is tax effective, but any remaining debt on your home isn’t. Therefore the loan on your home costs you much more on an ongoing basis than the loan on your investment property.
The property that you live in is not the only source of home equity. You can also use the equity in an existing investment property to help fund the purchase of another investment property.
Your Mortgage Choice broker can help you to work out how much equity you have in your property and how it can be accessed to fund your investment.
Steps to access equity
Calculate the available equity
Work out the amount of equity available in your property using the estimated market value of your home – commonly based on comparable sales within your area or a real estate agent valuation, less the balance of your current loans secured by the property.
Work out the “accessible” equity
Work out how much money is required to achieve your plans. You may or may not want to – or be able to – access the full amount of equity that’s available, and your servicing capability is an important factor in this discussion. That is, your ability to service any additional repayments may have an impact on the amount of equity that you can access. Say, for example, that you have $150,000 worth of equity in your property. However, the amount of additional repayments you can afford based on your income and expenses works out to be $50,000; then realistically that’s the amount you would proceed to unlock, rather than the full $150,000 that’s available.
Review your loan options
At this point of the process, you may want to start researching and assessing your home loan options with a Mortgage Choice broker. This is also a good opportunity for your broker to do a “health check” on your current home loan, comparing it based on factors such as interest rates, fees and features against other options from your current lender or other lenders in the market.
Work out the costs for accessing equity
The product you choose and the amount of equity you are looking to access may result in various fees and costs. For example, if you choose to access over 80 percent of your property's value, you will likely need to pay Lenders' Mortgage Insurance (LMI). If you decide to switch to another lender, there may be costs such as fees associated with breaking from a fixed rate product, new loan application fee or government fees.
Loan application and settlement
Once you've decided on a loan option with your Mortgage Choice broker, they'll work with you to get the application process underway and support you at every step to settlement.