One of the perks of homeownership is being able to build up equity in your property every time you make a mortgage payment – and over the years, the equity you accumulate may open opportunities for you to grow your wealth even further by allowing you to apply for a home equity loan.
But what exactly is home equity, and how can you tap it? Is it possible to use your home equity loan for any purpose? What are the drawbacks and benefits of releasing your equity assets? Here are some things to consider when taking out a loan for your home equity.
- What is a home equity loan?
- How to access your home equity
- How much equity can you borrow?
- How can you build equity in your home?
- What can a home equity loan be used for?
- Is a home equity loan right for you?
- Downsides to a home equity loan
What is a home equity mortgage?
Simply put, equity refers to how much property you own. Your equity is the difference in the current value of your home and what you owe on your mortgage. Your property may have been purchased for $300k. However, the value of your property over time could have doubled. Therefore, your home might be worth more than you thought.
As an example, say your home’s value now sits at $650k, and you still have $350k to pay back on the mortgage, which means you own the remaining $300k – this is your raw equity.
A home equity loan allows you to borrow against equity. Home equity loans can be obtained through banks and other lenders that allow you to use equity as collateral.
How to access your home equity
There are many ways to access your equity in your home. These options might not be all available to you.
Line of Credit
A line of credit acts a sort of credit card for your house, where you can access some of the existing equity you’ve built up in a property. A line is a type revolving credit that has a predetermined limit. It is based upon your home equity and is determined by your lender. This allows you to borrow up to the limit and repay the loan. You can also reborrow from the existing credit line during the draw period.
A variable interest rate is typically charged on a loan taken against a line credit. This type of home equity loan has variable repayments. They are only affected by the amount borrowed.
Helena applied for $100,000 in credit. Helena has the option to take all the money at once after she receives approval. If she wanted to invest in property, this would be a good option. On the other hand, she could opt to use only a portion of the line of credit — she can draw down $20,000 for a small investment and interest will only be charged on that amount.
For example, if she wanted to invest $50,000 in house renovations, she would have to pay interest at $70,000 ($50,000 renovating and $20,000 investing). Her credit line has $20,000 remaining, which she can use later on if needed.
You can capitalise interest on some lines of credit until you reach the limit or a certain percentage of the limit. This allows you to add repayments to the amount already drawn.
Credit lines are interest-only and you can build equity by putting money back into the facility.
These are typically more expensive in interest rates and may have a monthly or half-yearly fee. This may be from $10 per month to $600 per year, though most are in the $120–350 per year category.
There are large differences among products on the marketplace. Some remain interest-only for an initial period, say 10 years, and then turn into an amortising principal & interest loan. Be sure to consult your financial advisers before making any major decision regarding the equity you’ve built up in your home.
A lump sum home equity loan works like a typical home loan where you borrow an approved amount and make the necessary repayments – including interest – over a certain period.
A lump sum home equity loan typically has a fixed rate. This can range from 5 to 15 years. Before you can sell your home, you should be able repay the loan in full.
Refinancing can be one of the best ways to get equity out of your home. Refinance with your existing lender (internal) or with a new lender (“external” refinance). Your home must be valued to determine its current value before you refinance. If the property has risen in value since you bought it, your lender may give you the option of refinancing based on its new value, giving you access to the equity you’ve built up through your mortgage repayments.
It’s important to note that because you are digging into your equity, you will have to pay that back at some stage, plus interest.
Cross collateralisation is where you use the equity you’ve built up in one property to buy another property. This is a very risky practice because the property you currently own and the property you’re buying both become security on the loan. You could lose both your properties if you default on the mortgage payments. It’s important to note you can only cross collateralise with one lender.
If your mortgage has a redraw facility you can access the equity you’ve built up by drawing down on it.
A redraw facility allows borrowers to make extra repayments on their mortgage, and then withdraw (or ‘draw down’) on them later on. The redraw facility allows you to make additional repayments on your mortgage, and then withdraw them later.
Reverse mortgages are a type of home equity loan. This is normally reserved for those who have 100% ownership of their properties.
A reverse mortgage allows you release part of your property’s value, either as a lump sum or regular stream of income. This type of mortgage is not usually subject to monthly payments. However, lenders may charge interest and require you to repay the entire amount if the property is sold or if the retirees move into aged care or die.
What amount of equity can you borrow?
Different lenders have different policies about how much they will lend to home equity loans. This does not mean you can access the entire amount just because you have equity.
Most lenders want you to retain at least 20% of the property’s value as a form of security on your mortgage. If you want to use your home’s equity but still have a balance of more than 80% of the property’s value, you may also be required to pay for Lenders Mortgage Insurance (LMI).
This formula will calculate how much you can borrow.
(Home’s Value x 80%) – Mortgage Balance = Accessible Equity
If your home is valued at $600,000. and your outstanding balance is $250,000, your equity in your loan would be $350,000. You will need to determine how much equity you have by subtracting 80% from the value of your home and the outstanding balance.
($600,000 x 0.8) – $250,000 = $230,0000
You may be able, in this case, to access $230,000 from your $350,000 equity. LMI will be required if you borrow more than this amount.
How can you increase equity in your home and make it more valuable?
There are many ways to build equity in your home, but the most common and easiest are to reduce your loan amount and increase the property’s value.
Repaying your mortgage
Your equity in your home grows every time you make a payment. You can also increase equity by making additional payments on your home loan principal when you are able to.
Your property’s equity will also be affected by current market trends. It is possible that your home will be worth more now than it was when you took out your first mortgage.
Your home will be more valuable
Strategic renovations increase the value of your home, which in turn increases its equity. You might even be eligible to borrow against this equity to pay for your renovations.
What is the purpose of a home equity mortgage?
There are many reasons to get a home equity loan.
Consolidate your debt
You can consolidate your debts if you have enough equity in your home. Instead of having to pay it off in smaller payments, you can consolidate them all into one large payment. This can help you save interest rates and simplify the finances.
Renovations to your home
The loan amount can be used to finance home improvements that can increase your property’s value.
You can use the home equity loan to increase your wealth. It can also be used to buy shares, secure bonds, and start a business.
Lifestyle purchases and other major purchases
You can also access equity in your home to fund a range of personal expenses, including a child’s education, new car, wedding, or a holiday.
Are you looking for a home equity loan?
A home equity loan is available to individuals with unique financing needs, just like other options on the market. If you have the following conditions, a home loan equity loan might be right for you:
- You would like to have additional funds available without the need to sell your home
- You already have a substantial amount of equity in your loan
- You want to renovate, but don’t want to borrow money or use credit cards.
- You don’t need a separate mortgage to begin building your investment portfolio.
What are the negatives to getting a loan on your home equity?
The home equity loan is relatively easy to access, but it can be tempting to spend the money irresponsibly. Bear in mind that a certain level of financial discipline is needed for you to reap the full benefits of accessing your home’s equity.
It is important to remember that you will be increasing your debt by taking out a loan for your home equity. This will impact your ability to repay your loans. The loan will also require you to pay fees and charges. Unnecessarily tapping into your equity can lead to more debt. Be wise when deciding when to access it.
A home equity loan comes with its own set of risks. One of the pitfalls is that you could end up in worse financial shape if the amount you borrowed does not increase in worth. When renovating your home, you could end up overcapitalizing. If the renovation costs are higher than the property’s value, this is a problem. This can also occur if your property investment ventures fail.
Ask a mortgage broker for more information about your options
To get an expert opinion on whether a home equity loan is right for you, you can always contact a mortgage broker.
A mortgage broker can help you determine if your equity is sufficient to be eligible for this type loan. They can help you determine if borrowing against the equity in your home is a smart move based on your financial circumstances.
They can also provide other options that will be more suitable for your needs. Is refinancing your mortgage a better choice? Do you need a personal loan or refinance? These are the kinds of questions that mortgage brokers can help answer.