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Can I take out a loan against my home’s equity?
When you take out a loan to buy a home, you’re investing in an asset whose value may increase over time. Meanwhile, your regular principal and interest repayments slowly but surely pay off the loan. This growing difference between the value of your home and the outstanding loan amount is called home equity, which can also be a valuable asset.
For instance, you could leverage your home’s equity as a deposit to help you purchase a second property, or use the equity you’ve garnered to undertake renovations on your current property.
You can take steps to grow your home equity, such as making larger or extra repayments, or renovating your home to increase its value. But before you go about making the most of the equity in your home, you may need to get a formal property valuation done.
How does a loan against home equity work?
Before you can take out a loan against home equity you’ll need to work out the equity you’ve built in your home. Suppose you bought a home currently valued at $500,000 and you still owe $100,000 on the home loan. The present equity in your home is calculated as the difference between these two figures and amounts to $400,000.
However, many lenders will only allow you to access what they call usable equity, which is where you maintain an 80% loan-to-value ratio (LVR). So, in the previous example the lender would require you to keep 20% of the property value ($100,000) in the home, leaving you with $300,000 of usable equity to work with. Some lenders may allow you to access more if you pay Lender’s Mortgage Insurance (LMI).
You can then apply to release this usable equity by refinancing your existing mortgage or taking out a second mortgage.
Before a lender will approve an application to refinance a home loan to access your equity, they will need to conduct a valuation of the property to accurately determine your usable equity. Requesting your own separate valuation can help you get some idea of your home’s worth before going to the lender. You could also consider getting an appraisal when renovating your home to give you an idea of how much value the renovations may add.
What can a home equity loan be used for?
A home equity loan can be used for a variety of expenses. Some popular uses of home equity loans may include:
- Home renovations: A home equity loan can be used to fund renovations to increase your value or make the home a better fit as your needs change.
- Property or asset investment: Your home equity can help finance a down payment on an investment property or if you're planning to buy a new home.
- Debt consolidation: Home equity loans can be an option to help you pay off higher-interest debt because they usually have lower interest rates.
- Lifestyle affordability: Home equity can be leveraged to help fund large life expenses like a new car or even your own business.
How can I build up my home’s equity?
While your home equity will grow as you repay your home loan, you can take steps to increase it further. One option is to make larger or additional mortgage repayments, increasing the equity by bringing down your debt. However, you should check if your lender allows these sorts of extra repayments or if you’d need to pay additional fees for doing so.
Having an offset account may also help you increase the equity in your home. The funds in your offset account are included when calculating your interest charges, meaning you may pay less interest over the life of your loan. And as a smaller percentage of each mortgage repayment will be made up of interest charges, you'll effectively be paying extra towards reducing your home loan principal, shrinking your debt faster and building your equity. You’ll need to make sure all of this is possible with your lender before using an offset account to help increase your equity.
You can also grow your home’s equity by taking steps to improve the home’s worth by doing renovations. You may need to check with your current lender to make sure that any planned renovations don’t affect your loan terms. A change in your home’s worth implies a change in the security against your home loan, which may concern the lender.
How can I take out a loan against home equity?
Refinancing
This option may allow you to restructure your existing home loan and take advantage of your accumulated home equity. You’ll need to meet all the usual refinancing requirements in order to successfully deploy your home’s equity.
Second mortgage
Once you refinance and access your equity you could use it as a deposit for a new property purchase. You will then have a second mortgage on your new property. Your current property will be linked to your new purchase because you’ve used its equity as the deposit. However, this is considered incredibly risky as, if you default on your second mortgage, you may risk losing both properties. Second mortgages are not as commonly provided in Australia.
Line of Credit
A secured line of credit loan, also called a home equity loan, is a flexible loan that acts similarly to a credit card. It’s typically used for personal loan purposes, such as paying for renovations, medical bills, urgent repairs, weddings, and holidays.
Reverse Mortgage
Another example of a home equity loan is a reverse mortgage, which retirees can use to facilitate their lifestyle. A part of the value of the property is accessible as steady income or as a lump sum amount. The mortgage is repaid when the property is sold or if the borrower moves into an aged care home or passes away.
Compare home loans in Australia
Product database updated 28 Apr, 2024
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