18 April 2022

Understanding your home’s useable equity

Emma McLaren
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One obvious way to buy a new home is to sell your existing home. However, many people are unaware of how they can use the current equity in their home to purchase something else, all without needing to sell the original property. Leveraging equity is a powerful tool to use in building your investment capacities. By analysing the available equity in your home, you can identify opportunities to purchase more real estate without needing to sell the original asset.

This is an approach used by many owner-occupiers looking to enter the property investment arena. Rather than selling their family home, they can use the existing equity in their principal place of residence to fund an investment property.

Read on if you’re looking to learn more about leveraging useable equity.

The definition of home equity

Understanding home equity is a simple equation. The difference between the property’s current market value and the debt held against it (such as a mortgage). Alternatively, you can consider the equity in your home as how much of it is owned outright. If you’ve been paying your home off over several years, or you’ve experienced an upswing in property values, there’s a good chance you’re sitting on some useful home equity.

While there’s no one-size-fits-all approach to building a property investment strategy, using existing equity is popular for many Australian investors. Whether or not this is an option comes down to individual factors, such as the value of the original property, the financial position of the applicants, the potential rental yield of a new investment property and more.

Depending on the amount of equity available, you may be in a position to finance the entire purchase price of your investment property. This can include additional costs, such as stamp duty and transfer fees, making this an attractive proposition for many new investors looking to maintain their regular cash flow position.

The ability to leverage this equity is also dependent on fluctuations in property prices. If there was a sudden dip in property prices, the original home loan could become exposed if too much equity is leveraged. Different investors will approach their leveraged equity based on their risk appetites and the factors of their investment market.

Generally, banks are willing to lend up to 80% of the current home's value, taking into account any debt owed against the property.

Going beyond investment properties

While one of the most obvious uses of home equity is to purchase an investment property, this isn’t the only reason many Australians opt to leverage their equity.

Other common factors include:

  • Financing a renovation.
  • Investing in shares or funds.
  • Major life events such as new cars and family holidays.

This is a popular strategy for owner-occupiers who are also looking to buy into markets in entry-level properties. Often, they’ll wait a few years for their equity to increase before tapping back into it to invest in significant renovations.

Calculating your home’s useable equity

While you’ll need to talk to lenders directly to understand your position, here’s a scenario where useable equity is identified.

Let’s assume you live in a home worth $1,000,000, with a mortgage of $600,000 on the property. Keeping in mind that most banks will limit their lending to 80% of the home’s current value, here’s how you would identify the amount of useable equity.

  • Home value: $1,000,000 x 0.80% = $800,000

  • Remaining debt: $600,000

  • Potential useable equity = $800,000 - $600,000 = $200,000

In this scenario, you could maintain your existing mortgage, keep your home and access $200,000 of equity.

Banks will also need to see evidence that you can support the repayments of the new loan amount. If you’re increasing your loan by 20% to pull down a significant portion of equity, your income and expenses will be scrutinised to evaluate this.

Factors in accessing equity

Unfortunately, accessing useable equity isn’t as simple as waltzing into the bank and asking for a cheque. Several factors impact your costs to do so. These are worth considering if you’re looking to access equity to create an investment opportunity, as the cost can impact your overall return on investment.

If you’d like to access more than 80% of your useable equity, you’ll be required to pay lenders’ mortgage insurance (LMI). This insurance is designed to protect the lender if you default against your loan payments. The cost of this is different from lender to lender and is based in part on loan to value ratio (LVR) of your new total loan.

Often, accessing equity may require refinancing your mortgage. If you need to do so, you’ll also need to factor in any costs around switching lenders. These can include application fees and government fees. If you’re on a fixed rate, there may also be a break fee that’s incurred due to leaving your fixed mortgage agreement before its end date.

You’ll also need to consider the competitiveness of current interest rates. These may have changed since you last purchased a home, meaning you’ll need to calculate your repayments based on the product offering of the new loan offered to you.

Line of credit loans

One option for those looking to access their equity is to use a line of credit loan. Typically, these have higher interest rates than variable home loans. These can present a danger if you’re borrowing to a limit where you can no longer meet the monthly repayments. Line of credit loans can easily offer access to significant funds, presenting a risk for those who aren’t disciplined in their repayments or who may not have adequately calculated their ongoing monthly repayments. This is particularly risky if you’re looking to use your equity to fund something like a holiday, as it doesn’t generate an income.

These loans are most suited to homeowners who have a high degree of financial literacy and enough of a buffer fund to protect them from defaulting on their loan payments if their circumstances change.

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