When the housing market goes through a period of growth and house prices increase, often home-owners find the value of their homes increases accordingly. The difference between what you owe on your home loan and the value of your property is called equity. This article explores what equity is and how you can use it.
What is equity?
Equity is the accumulated worth of your property after subtracting the amount you still owe on the home loan. If you’ve owned your home for a few years and have been paying down the principal of your loan then there’s a good chance you have accumulated equity in your property.
Here’s a simple example:
Hannah & Ella own a home worth $800,000. They still owe $500,000 on their home loan. Therefore, they have $300,000 worth of equity. If Hannah & Ella wanted to refinance and access the equity, their lender will happily let them increase their borrowing up to 80% LVR without needing to pay LMI. This means they could access $140,000 worth of equity.
What can home equity be used for?
Your lender won’t let you access equity in your property for just any reason though. The primary reasons people access equity are:
- To use as a deposit on an investment property
- Renovate your current home to increase liveability and value
- Use equity for other investments such as shares or other assets
- Consolidating debt
Using equity to buy an investment property
A home equity loan lets you borrow against the equity of your home. This means you don’t need to save a cash deposit to purchase an investment property. This is a very common way Australians purchase investment properties and investment lending is often structured around using the equity in an existing property.
It’s basically how all of these property gurus manage to accumulate “20 properties before the age for 30” – they would use equity from the property they own to purchase the next one, and so on. Regulatory changes and credit assessment gave made this a bit harder to do, with debt-to-income ratios now in play and investment lending assessed based on P&I repayments.
Before you go bidding on an investment property, it’s a good idea to chat with your Entourage broker first. We’ll check your serviceability and possible equity and make sure it’s feasible for you.
Renovate your current home
You can also access equity to renovate your home. This might be to add value to the property or to improve the liveability for your family. If you are planning on a knock-down and rebuild you won’t be able to simply access equity (subject to the value of the build) you will likely need a construction loan to do this.
Use equity for other investments
Some people choose to access equity to invest in other asset classes such as managed funds, businesses, shares or bonds. There are lots of different vehicles for investing in, which is why it’s key to speak to a qualified Financial Planner first. This ensures your actions are aligned with your overall wealth accumulation goals, risk profile and objectives.
Consolidating debt
Another common reason for people will draw equity from their homes is to consolidate smaller debts. By taking a small amount from equity you can make huge savings in your monthly out of pocket expenses. It’s important that you still set a timeline to pay the monies back – ideally you don’t want to be paying off a car for the next 20 years via your home loan when you no longer own the car.
For example if you take $10,000 worth of equity to pay out a car loan that had two years left on it, try and ensure the $10,000 is paid out over the two year period. This would mean making additional repayments above your minimum repayments of at least $417 per month (plus extra to cover interest charged).
Equity isn’t free money
It’s important to remember equity isn’t free money. You are increasing the principal loan balance against your property, and you still have to repay this over the agreed loan term. If investing or renovating is something you’re ready to consider, get in touch below and we’ll explore what’s possible with you.