Guide to Accessing Your Home’s Equity
Accessing home equity is a shrewd way to free up funds that you can invest in other places. In many cases, the income you receive from your investment will even outweigh the interest you pay on your loan.
In this guide, we’ll give you an overview of the equity options at your disposal, along with some common ways people use equity in their home to create more wealth.
- You can earn equity in your home by repaying your mortgage and making renovations that improve the property value. You may also gain equity if your home’s value increases over time.
- You can access your home equity through multiple different loan types; some are riskier than others.
- Use your equity to fund new investment purchases or renovations that increase your overall wealth.
Home Equity Explained
As you can tell from the infographic here, the equity is the amount of the home that you own. Calculating your theoretical equity is as simple as subtracting your loan balance from the current property value of the house.
Unfortunately, this calculation can only offer you the theoretical equity you have in your home. When you’re looking to refinance and unlock equity, your bank will usually send a home valuation expert to conduct an official valuation of your home.
It’s not uncommon for these professionals to find a flaw or two in your home that reduces the perceived market value. Fortunately, there are a few steps you can take to increase the amount of equity you have in your home.
Increasing Your Equity
Property prices naturally rise and fall over time. Some of the factors that dictate your home’s value are out of your control.
If people move out of town and surrounding property values fall, yours likely will as well, and you’ll lose equity. If your neighbours renovate their homes and create more interest among buyers, your property may increase in value, and you’ll gain equity.
Although you can’t control the local market, you can take some steps to increase the equity you have in your home.
Paying down your mortgage faster than you originally planned is a smart way to increase your equity. Paying a little extra each month adds up over the course of a year, and results in more equity you can access at a later date.
Of course, this strategy does not impact the value of your home. It’s possible that your house will depreciate in value over the year, and lead to you losing equity – even with your additional repayments.
A renovation is a popular way to gain home equity since you’re improving value and making your home more to your tastes at the same time. Instead of paying the bank, you’re investing more funds in your property and increasing your stake.
Renovating your home is generally considered a responsible use of your current home equity. You can increase property value and subsequently own a larger percentage of the house.
Accessing Your Equity
There are a few different ways to access home equity. You can use redraw facilities, line of credit (or equity) loans, or refinance to unlock your home equity.
Most banks allow borrowers to make additional repayments on their variable rate loans. Additionally, your lender may then allow you to access these funds in the form of a redraw facility.
Redraw facilities don’t let you access the full amount of your equity, but they can provide some funds if you want to complete smaller-scale renovations or purchases.
Most lenders offer unlimited redraw facilities on their variable rate loans, which means you can access any amount you made in extra repayments. If you’ve paid an additional $50,000 on your loan balance ahead of schedule, for instance, your redraw facility will allow you to withdraw these funds.
The benefit of redraw facilities is that they don’t add any extra cost to your current loan. Your interest payments will rise since you’re taking away your additional repayments, but you won’t put yourself in further debt like you would with some of the other options.
Refinancing is one of the most common ways to unlock the equity in your home. It’s especially useful if your home’s value has increased over time. Refinancing lets you access your equity and use it to fund investments, further increasing your wealth.
When you refinance to access equity, you’re using the equity in your home as collateral to obtain a larger loan. You can then use the funds for things like renovations or to purchase an investment property.
Most of the time, lenders will release up to 80% of your equity without paying lenders mortgage insurance, or LMI. This is a type of insurance borrowers are sometimes required to pay when they have a small deposit. It protects the lender in the event that the borrower cannot make their scheduled repayments.
Line of Credit
You can access your equity through an approved line of credit loan as well. This works much like a credit card with a massive credit limit. You can draw funds from the line of credit as needed, repay the funds, and then draw them down again.
Your lender bases the credit limit on your equity, and you only pay interest on the portion of the available funds that you use.
Cross-collateralisation is riskier than refinancing, and it is generally used by investors to purchase investment properties. Instead of releasing the equity to use as you choose, the bank uses the equity on your current home as security for a new loan.
With cross-collateralisation, you are essentially using two properties as security against a loan: the property that holds the equity (possibly your place of residence) and the property you are purchasing with the new loan.
People who don’t have enough equity to refinance might be attracted to this way of accessing home equity, but it’s risky. Defaulting on your loans enables the bank to repossess both properties.
Using Your Equity
Once you’re through accessing your home equity, you can use it for a long list of things – some more advisable than others. Here, we’ll take a look at two of the most common uses for home equity loans that might make you more money than you’re paying in interest.
Most of the time, homeowners refinance to cover a deposit for an investment property. You can then rent out the new property, with the goal of covering your mortgage repayment and any applicable fees, plus a bit of extra income if you’re lucky.
Using this strategy, you can build your property portfolio and continue to grow your wealth. Ideally, you’ll earn equity in the new property, renovate, refinance, and repeat the process.
Renovations are an alternative to investing. Instead of investing in a new property, substantial renovations increase the value of your present home and make it more attractive to potential buyers.
Homeowners commonly renovate their houses with their unlocked equity if the funds are not enough for an investment purchase. With renovations, you’re essentially borrowing from your current equity to create more equity in your home.
Risks of Accessing Home Equity
Accessing home equity isn’t always the best option. It can free up money for other investments and renovations, but it carries a risk you should be aware of.
The first risk is the same with anything involving money: temptation. The influx of funds might tempt you to spend the money on a new car or a holiday. In this case, you could wind up in debt instead of owning property.
Another risk is depreciation. It’s possible to lose equity in your home from forces outside of your control. In fact, you could even have negative equity if the cost of the mortgage is more than the value of the house.
Finally, borrowing from your home’s equity means that you’ll have to repay that loan to build your equity back up. Accessing your home equity is not free money; when you draw funds from your equity in the form of a loan, your lender gains a higher proportion of ownership over the property.
When borrowing against your home equity, consider how you will repay the loan before moving forward.
Take care to consider your options when you refinance. Use our calculator below to start looking for home loans that fit your needs!