Looking to use your home equity to refinance?

Whatever your reason for thinking about refinancing your home loan, your ability to do so will depend on a variety of factors, with your amount of available equity being one of the most important.

What is equity, and how much do you have?

Equity is essentially the difference between the current value of your property and the amount you owe on your mortgage principal. To put it another way, the equity in your home is how much of your property that you own for yourself, and not your mortgage lender.

You can find your level of equity using the following basic formula:

Equity = property value – amount owing on your mortgage principal

Keep in mind that your property value isn’t just the price you paid when you bought the place – it also includes any capital gains from making improvements to the property, or from increased demand in your local area.

Example:

Jacob buys a property worth $500,000, paying a 20% deposit of $100,000 and borrowing $400,000 in a home loan. Over the following years, he pays back another $100,000 onto the loan principal, leaving $300,000 owing. Meanwhile, Jacob’s improvements to his property and the increasing popularity of his local area leads to his property’s estimated market value rising by $100,000 to $600,000.

To work out his current level of equity, Jacob subtracts the amount owing on his mortgage ($300,000) from the current market value of his property ($600,000). Jacob has $300,000 in equity available to use when refinancing.

How can you use your equity to refinance?

There are a few ways that your equity can be used, depending on your refinancing goal. Generally, your equity will play a similar role to that of your deposit when you first took out your home loan – providing security and reducing the lender’s financial risk.

If you’re refinancing your existing loan to lower your interest rate, whether so you can enjoy more affordable mortgage repayments, or so you can pay back your loan’s principal more quickly, the more equity you have available in your mortgage, the more security you’ll offer your lender, and the lower an interest rate you’re likely to receive. You may also qualify for loans with access to useful features such as offset accounts and redraw facilities, which can provide further flexibility and options for managing your finances.

Example:

Jacob considers refinancing his home loan by switching to another lender with a lower interest rate. Because he has more than $120,000 in equity available (the minimum 20% deposit required to avoid paying Lender’s Mortgage Insurance), he qualifies for one of his new lender’s low-interest loans with an offset account and a redraw facility, so he can enjoy greater flexibility from his personal finances.

Home loans for refinancing:

If you’re refinancing in order to borrow more money, such as when you want to upgrade to a bigger house, the equity in your current home loan can serve as the deposit on a new home loan, with all of the same requirements.

Keep in mind that a new home loan comes with new fees, charges and expenses such as stamp duty, which often average to around 5% of the purchase price. Take this into account when estimating what you may be able to afford. 

Example:

Jacob considers selling his current place and buying a new one in a better area, which will require refinancing his mortgage and borrowing more money.

With $300,000 in equity available, and assuming that his new loan will require a minimum 20% deposit to avoid Lender’s Mortgage Insurance (LMI), Jacob could theoretically buy a place worth up to $1.5 million… assuming he can afford the repayments and the costs of refinancing!

To hopefully keep his finances more manageable, Jacob instead looks at homes worth up to $1.2 million, using $240,000 of his equity as a deposit and keeping the remaining $60,000 available to cover the other costs.

It’s also possible to keep your current home loan and property, and to use your equity to fund the purchase an investment property. However, in this case, you likely won’t be able to put all of the equity in your current loan towards taking out a new one – many lenders require you to maintain a minimum Loan to Value Ratio (LVR) in your mortgage to help limit the financial risk involved. You’ll need to take LVR into consideration when determining the amount of usable equity in your home.

Example:

Another option for Jacob is to use the equity in his home to take out a second mortgage to purchase an investment property. Because Jacob’s lender requires that he maintains a minimum LVR of 80%, his property value for determining his usable equity effectively becomes $480,000 ($600,000 – 20%). This in turn means that Jacob’s usable equity is only $180,000, rather than the original $300,000 figure.

Assuming Jacob’s second mortgage requires a 20% deposit to avoid LMI, he could potentially buy an investment property valued at up to $900,000, but it may be more affordable to look at $720,000 properties, using $144,000 as the deposit and keeping $36,000 to cover the other expenses involved.

Another option is to take out a home equity loan, also known as a line of credit, where you borrow money from your lender using the equity in your home loan as collateral. This line of credit could be used to finance a home renovation, to buy a new car, or to pay for a dream holiday.

Much like the previous investment property example, you may be limited on how much you can borrow in a home equity loan, as your lender may require you to keep a certain percentage of your home’s value invested in the property in order to secure the mortgage.

Example:

Another option for Jacob is to use his equity to pay for that big round-the-world trip he’s always wanted to go on. As previously determined, he has $300,000 of equity in his home loan, but only $180,000 of this is usable equity.

By approaching his lender and organising a home equity line of credit, Jacob can set off on his trip, armed with what is effectively a credit card with a $180,000 limit. 

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Learn more about home loans

What is equity? How can I use equity in my home loan?

Equity refers to the difference between what your property is worth and how much you owe on it. Essentially, it is the amount you have repaid on your home loan to date, although if your property has gone up in value it can sometimes be a lot more.

You can use the equity in your home loan to finance renovations on your existing property or as a deposit on an investment property. It can also be accessed for other investment opportunities or smaller purchases, such as a car or holiday, using a redraw facility.

Once you are over 65 you can even use the equity in your home loan as a source of income by taking out a reverse mortgage. This will let you access the equity in your loan in the form of regular payments which will be paid back to the bank following your death by selling your property. But like all financial products, it’s best to seek professional advice before you sign on the dotted line.

What is a line of credit?

A line of credit, also known as a home equity loan, is a type of mortgage that allows you to borrow money using the equity in your property.

Equity is the value of your property, less any outstanding debt against it. For example, if you have a $500,000 property and a $300,000 mortgage against the property, then you have $200,000 equity. This is the portion of the property that you actually own.

This type of loan is a flexible mortgage that allows you to draw on funds when you need them, similar to a credit card.

What is equity and home equity?

The percentage of a property effectively ‘owned’ by the borrower, equity is calculated by subtracting the amount currently owing on a mortgage from the property’s current value. As you pay back your mortgage’s principal, your home equity increases. Equity can be affected by changes in market value or improvements to your property.

Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

What is a low-deposit home loan?

A low-deposit home loan is a mortgage where you need to borrow more than 80 per cent of the purchase price – in other words, your deposit is less than 20 per cent of the purchase price.

For example, if you want to buy a $500,000 property, you’ll need a low-deposit home loan if your deposit is less than $100,000 and therefore you need to borrow more than $400,000.

As a general rule, you’ll need to pay LMI (lender’s mortgage insurance) if you take out a low-deposit home loan. You can use this LMI calculator to estimate your LMI payment.

What is a loan-to-value ratio (LVR)?

A loan-to-value ratio (otherwise known as a Loan to Valuation Ratio or LVR), is a calculation lenders make to work out the value of your loan versus the value of your property, expressed as a percentage.   Lenders use this calculation to help assess your suitability for a home loan, and whether you need to pay lender’s mortgage insurance (LMI). As a general rule, most banks will require you to pay LMI if your loan-to-value ratio is 80 per cent or more.   LVR is worked out by dividing the loan amount by the value of the property. If you are looking for a quick ball-park estimate of LVR, the size of your deposit is a good indicator as it is directly proportionate to your LVR. For instance, a loan with an LVR of 80 per cent requires a deposit of 20 per cent, while a 90 per cent LVR requires 10 per cent down payment. 

LOAN AMOUNT / PROPERTY VALUE = LVR%

While this all sounds simple enough, it is worth doing a more accurate calculation of LVR before you commit to buying a place as there are some traps to be aware of. Firstly, the ‘loan amount’ is the price you paid for the property plus additional costs such as stamp duty and legal fees, minus your deposit amount. Secondly, the ‘property value’ is determined by your lender’s valuation of the property, not the price you paid for it, and sometimes these can differ so where possible, try and get your bank to evaluate the property before you put in an offer.

What are the pros and cons of no-deposit home loans?

It’s no longer possible to get a no-deposit home loan in Australia. In some circumstances, you might be able to take out a mortgage with a 5 per cent deposit – but before you do so, it’s important to weigh up the pros and cons.

The big advantage of borrowing 95 per cent (also known as a 95 per cent home loan) is that you get to buy your property sooner. That may be particularly important if you plan to purchase in a rising market, where prices are increasing faster than you can accumulate savings.

But 95 per cent home loans also have disadvantages. First, the 95 per cent home loan market is relatively small, so you’ll have fewer options to choose from. Second, you’ll probably have to pay LMI (lender’s mortgage insurance). Third, you’ll probably be charged a higher interest rate. Fourth, the more you borrow, the more you’ll ultimately have to pay in interest. Fifth, if your property declines in value, your mortgage might end up being worth more than your home.

How much are repayments on a $250K mortgage?

The exact repayment amount for a $250,000 mortgage will be determined by several factors including your deposit size, interest rate and the type of loan. It is best to use a mortgage calculator to determine your actual repayment size.

For example, the monthly repayments on a $250,000 loan with a 5 per cent interest rate over 30 years will be $1342. For a loan of $300,000 on the same rate and loan term, the monthly repayments will be $1610 and for a $500,000 loan, the monthly repayments will be $2684.

How much can I borrow with a guaranteed home loan?

Some lenders will allow you to borrow 100 per cent of the value of the property with a guaranteed home loan. For that to happen, the lender would have to feel confident in your ability to pay off the mortgage and in the security provided by your guarantor.

How do I take out a low-deposit home loan?

If you want to take out a low-deposit home loan, it might be a good idea to consult a mortgage broker who can give you professional financial advice and organise the mortgage for you.

Another way to take out a low-deposit home loan is to do your own research with a comparison website like RateCity. Once you’ve identified your preferred mortgage, you can apply through RateCity or go direct to the lender.

How do I refinance my home loan?

Refinancing your home loan can involve a bit of paperwork but if you are moving on to a lower rate, it can save you thousands of dollars in the long-run. The first step is finding another loan on the market that you think will save you money over time or offer features that your current loan does not have. Once you have selected a couple of loans you are interested in, compare them with your current loan to see if you will save money in the long term on interest rates and fees. Remember to factor in any break fees and set up fees when assessing the cost of switching.

Once you have decided on a new loan it is simply a matter of contacting your existing and future lender to get the new loan set up. Beware that some lenders will revert your loan back to a 25 or 30 year term when you refinance which may mean initial lower repayments but may cost you more in the long run.

Can I change jobs while I am applying for a home loan?

Whether you’re a new borrower or you’re refinancing your home loan, many lenders require you to be in a permanent job with the same employer for at least 6 months before applying for a home loan. Different lenders have different requirements. 

If your work situation changes for any reason while you’re applying for a mortgage, this could reduce your chances of successfully completing the process. Contacting the lender as soon as you know your employment situation is changing may allow you to work something out. 

How do I know if I have to pay LMI?

Each lender has its own policies, but as a general rule you will have to pay lender’s mortgage insurance (LMI) if your loan-to-value ratio (LVR) exceeds 80 per cent. This applies whether you’re taking out a new home loan or you’re refinancing.

If you’re looking to buy a property, you can use this LMI calculator to work out how much you’re likely to be charged in LMI.

Are bad credit home loans dangerous?

Bad credit home loans can be dangerous if the borrower signs up for a loan they’ll struggle to repay. This might occur if the borrower takes out a mortgage at the limit of their financial capacity, especially if they have some combination of a low income, an insecure job and poor savings habits.

Bad credit home loans can also be dangerous if the borrower buys a home in a stagnant or falling market – because if the home has to be sold, they might be left with ‘negative equity’ (where the home is worth less than the mortgage).

That said, bad credit home loans can work out well if the borrower is able to repay the mortgage – for example, if they borrow conservatively, have a decent income, a secure job and good savings habits. Another good sign is if the borrower buys a property in a market that is likely to rise over the long term.