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What is a home equity loan?

A home equity loan is where you use the equity in your home as security to borrow money. This may allow homeowners additional financial flexibility to meet their personal and financial goals. 

There are two main types of home equity loan:

  1. Lump sum: Similar to a personal loan, car loan or mortgage, this uses your equity as security to borrow a large sum of money, which you’ll pay back with interest over time, at either a variable rate or a fixed rate.
  2. Line of credit: Similar to a credit card, this lets you borrow and repay money when you need it, up to a maximum limit based on your available equity. You’ll only be charged interest on the money you’ve borrowed.

Reverse mortgages

Another type of home equity loan is the reverse mortgage. Typically, only available to retirees who own their home outright, a reverse mortgage lets you access part of the value of your property as a lump sum or as a regular income stream. This loan amount can be repaid whenever you choose, including when you sell your home, move into aged care, or pass away.

Is a home equity loan the same as a line of credit?

While you have the option to access your home equity loan as a line of credit, it’s also possible to secure a line of credit without using your home equity.

Some lenders offer lines of credit secured by other assets, such as vehicles. Unsecured lines of credit are also available, though these tend to have higher interest rates and tougher eligibility criteria.

Depending on your loan purpose, you may prefer to access your home equity loan as a lump sum rather than a line of credit. For example, a lump sum could help you pay for a single large expense like a wedding or buying a new car, while a line of credit could be useful if you don’t yet know how much money you’ll need for a longer-term project, such as home renovations.

What is equity?

Your equity in your home is the percentage of its value that you own outright, and does not a have a mortgage owing on it. This includes the repayments you’ve made onto your mortgage principal (including additional repayments), as well as any capital growth your property has experienced from rising prices in your area. 

The more you can pay off your mortgage, and the more your property’s value increases, the more equity you may have in your home. 

How do you calculate home equity?

The easy way to find your home equity is with this formula: 

  • Current home value – outstanding mortgage = equity

Remember that your home’s value may have changed in the time since you bought the property. If you don’t know your home's current market value, you can get an estimate by ordering a property report. Keep in mind that your lender will likely require a professional valuation as part of your line of credit’s application process.

You can find the loan balance still owing on your current home loan by checking your statements from your mortgage provider.

What is usable equity?

It’s important to remember that just because you have equity in your home, that doesn’t always mean all of your equity is available for you to use.

Mortgage lenders typically want you to hold onto at least 20 per cent of your home’s value to keep your home's loan to value ratio (LVR) under 80 per cent. If you owe money on more than 80 per cent of your home’s value, whether it’s through your mortgage, a home equity loan, or both, you may need to pay for a lender's mortgage insurance (LMI) policy.

To find your usable equity, you can use the following formula: 

  • (Current home value x 0.80) – outstanding mortgage = usable equity

For example, if your home is currently valued at $500,000, and you still have $300,000 to pay off on your mortgage, you have $200,000 in equity. However, 80 per cent of your home value is $400,000, so once you subtract the $300,000 you still owe on your mortgage, you’ll have $100,000 available in usable equity.

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How can you grow or increase your home equity?

The simplest way to build equity in your home is to pay off your mortgage. The more extra repayments you can make onto your home loan principal, the more equity will become available in your property.

If you’ve been keeping up with your home loan's monthly repayments for a few years, you may find that you have more equity available in your property than you expect. This is because equity is calculated using the current value of your home – if house prices have been rising in the local area, your property may hold more value today than it did when you first applied for your mortgage.

You may also be able to increase the value of your home (and your home equity with it) by renovating the property. This could be as simple as replacing old fixtures or as complex as replacing the kitchen or bathroom, adding bedrooms, or even putting an extra storey on your house.

You may even be able to use money from a home equity loan to pay for renovations. If they help increase your home’s value, you may find you have more equity available in the future to borrow more money when you need it. Just be mindful of the risk of overcapitalising, where the cost of the renovations is higher than the potential value increase.

How can you use a home equity loan?

Depending on your financial situation, you may be able to use your home equity to access a lump sum or a line of credit to:

  • Consolidate debts: You may be able to clear maxed-out credit cards or other outstanding loans, and often pay a lower interest rate than you would by clearing each debt separately.
  • Improve the home: Paying for renovations, extensions, repairs or other construction projects around the house can help improve your quality of life and/or increase the property’s value
  • Invest in the future: Pay for education, start a business, invest in shares… there are a lot of options that could help you build wealth and/or value in the future.  
  • Pay for goods and services: Buy a car, pay for a wedding, go on holiday… however you choose to spend your money, you may be able to enjoy a lower interest rate than many personal loans or credit cards.

How does equity work when buying a second home?

You may be able to refinance your home loan and use your usable equity as security on a second mortgage to buy an investment property. A common rule of thumb is to look for an investment property priced at four times your usable equity, so your loan can cover the cost of the property plus stamp duty and other fees and charges.   

Some property investors purchase multiple houses using this strategy, using the equity in one property as security to purchase the next, and so on. Keep in mind that this strategy can be risky – if you find yourself unable to afford one loan, you could end up losing both properties.

Consider contacting a financial adviser and/or a mortgage broker before you look at buying an investment property with your home equity.  

How do you find and compare home equity loans?

You can do your own research on home equity loans by sourcing information from various lenders and financial institutions, though that may take a long time and require more effort.

A comparison site like RateCity allows you to view a wider range of home equity loan offers side by side, and use filters to narrow down your shortlist to just the home equity loans that best suit your financial needs.

Can a broker help with a home equity loan?

While you may expect a mortgage broker to be mostly concerned with home loans, these mortgage experts can also assist you with refinancing your current mortgage to access a home equity loan. If you want to use your equity to buy an investment property or second home, these home loan experts can help you manage this process as well.

A mortgage broker can help you on every step of finding and applying for a home equity loan, from calculating your approximate usable equity to negotiating with the lender to help you get a better deal.

Is a home equity loan secured or unsecured?

Home equity is the difference between its current market price and the outstanding balance on the mortgage loan. The amount you can borrow against the equity in your property is known as a home equity loan.

A home equity loan is secured against your property. It means the lender can recoup your property if you default on the repayments. A secured home equity loan is available at a competitive rate of interest and may be repaid over the long-term. Although a home equity loan is secured, lenders will assess your income, expenses, and other liabilities before approving your application. You’ll also want  a good credit score to qualify for a home equity loan. 

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.

Can I borrow extra on my mortgage for furniture?

Yes, you may be able to borrow extra on your mortgage for furniture. This may be done by considering a home equity loan. A home equity loan may allow you to access the equity in your mortgage for furniture via:

  • A line of credit – A pre-approved credit limit based on your equity.
  • A lump sum payment – Like a persona loan, with equity in your home loan used as security.

If you want to avoid borrowing more money, consider accessing cash deposited into your offset account or drawing down on extra repayments with a redraw facility to fund furniture purchases.

How fast can you get a home equity loan?

Completing an application for a home equity loan may only take 20 to 30 minutes. It may take a lender anywhere from a day to a few weeks to process and approve your application. This may be affected by your financial situation, your level of equity, and whether or not your lender needs to organise an in-persona valuation of the property.

 Before you can apply for a home equity loan, you’ll need to build up some equity in your property. The more money you can put towards extra repayments to reduce your home loan principal, the faster you can increase your equity. Also, if property values in your area increase, this may help deliver an instant equity increase once your property has been valued.

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.

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