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Understanding home equity loans

Jodie Humphries avatar
Jodie Humphries
- 6 min read
Understanding home equity loans

One of the many advantages of being a homeowner is the potential to build equity in your property with each mortgage payment. Through time, the equity you've built up may provide you with new opportunities to increase your wealth.

But what exactly is home equity, and how can you access it? What can home equity be used for? What are the advantages and drawbacks of utilising your equity to get a loan? These are just some of the questions you may want to answer before accessing your equity and taking out a home equity loan.

What is home equity?

Home equity is the difference between the amount you owe on your mortgage and the current value of your home. For example, imagine your home is currently worth $500,000, and you owe $100,000 on your mortgage. In this scenario, the equity in your home is around $400,000. 

How can you calculate your home equity?

You can calculate how much home equity you may have by working out the value of your property and subtracting your home loan balance from it. 

To get an idea of your property’s value, you can utilise listings of recent sales in your suburb. This will allow you to compare the prices of similar properties and estimate how much your home is worth. 

Alternatively, you could order a free property report to get an estimate of your property’s value. 

When you apply for a home equity loan, the lender will hire a professional valuer to calculate the exact value of your property. You can also hire a valuer to get a more precise assessment, though you’ll need to pay their fee.

What is a home equity loan?

A home equity loan gives you access to the equity you’ve built up in your property. The term home equity loan covers a range of loans, including line of credit loans, renovation loans, and senior loans. 

Typically you’ll be refinancing your current mortgage to access the equity in your property. Lenders will therefore calculate the usable equity you have, which is the equity they’re willing to lend you without charging you Lenders Mortgage Insurance (LMI). Your usable equity is often 80 per cent of your property's current value minus the amount still owing on your mortgage. 

To follow the previous example, 80 per cent of the property’s $500,000 value is $400,000. Subtracting the $100,000 balance owing on the mortgage, this gives you $300,000 in usable equity. 

Keep in mind that each lender will have its own eligibility criteria for home equity loans, and you may not always be able to access all of your home equity.

How to build equity in your property

Besides making regular mortgage repayments, there are several ways you could try building equity in your property. 

1. Increase the value of your property

One simple way to potentially increase the value of your property is to make small home improvements or renovations. This may be one of the easiest ways to build equity besides making mortgage repayments. By renovating to increase the value of your property, you can increase the equity you have in that property.  

Some of the simple improvements you could consider if you are looking to renovate include: 

  • Internal or external painting
  • Landscaping
  • Roof replacement
  • Floor replacement
  • Bathroom renovation
  • Addition of a new bathroom
  • Kitchen renovation
  • Expansion of storage such as built-in wardrobes

The amount you spend on the renovations or improvements will affect the amount of equity it may create. For instance, repainting or re-landscaping may not cost much, but it also may not change the value by a lot. Whereas a bathroom or kitchen renovation will likely cost a lot, but could potentially add a lot of value to the property. 

Deciding on how much to spend on renovations will depend on your situation. If you plan to sell the property, it’s recommended not to spend more on renovations than you hope to recoup when you sell the property.

2. Making additional lump sum repayments

If your mortgage allows you to make additional repayments without incurring a fee, it can be an effective way to increase your equity and decrease the amount of interest you’re paying on your mortgage. Check your home loan terms to ensure there aren’t fees for these payments. For instance, many fixed-rate home loans won’t allow additional repayments without a fee. 

3. Making more regular repayments

If you can change your regular repayments from monthly to fortnightly or weekly, you may pay less interest overall, and it could help you increase the equity. If you’re considering this option, discuss it with your lender to find out how to make this work. Also, make sure that you choose a payment frequency that suits your pay cycle. You don’t want to change your repayments if it causes financial distress.

What can a home equity loan be used for?

A home equity loan could be used for a variety of large expenses. Some popular uses of home equity loans may include:

  • Home renovations: A home equity loan can be used to fund renovations to increase its value or make the home a better fit as your needs change.
  • Property investing: 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. 

Other examples of home equity loans include reverse mortgages, which retirees take out to help facilitate their retirement lifestyle.

A home equity loan allows you to access money held in your property without having to sell your home. However, it's important to understand that taking out a home equity loan means increasing your debt and changing your repayments. There might also be fees that come with taking out the loan, so ensure you understand all the financial impacts before deciding. 

Home equity guidelines

Know what are the guidelines for home equity loans

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Product database updated 30 May, 2024

This article was reviewed by Personal Finance Editor Mark Bristow before it was published as part of RateCity's Fact Check process.