As you chip away at your mortgage or your property rises in value, the equity you have in your home increases. You can then choose to use the equity in your home for actions you may not otherwise be able to take. This may include funding renovations, making additional investments, or supplementing your income.
If you have been wondering how home equity works and what options you have to harness it, we’ve got you covered.
First Of All, What Is Home Equity?
To put it simply, home equity is the gap between what your home is worth and what you still owe on your loan. If your property is valued at $1,000,000 and you have $600,000 remaining on your loan, your equity equates to $400,000.
Not all of that equity will be accessible. Lenders tend to cap usable equity at around 80% of your property’s value, less what you still owe. So, if we stick with the example above, 80% of $1,000,000 is $800,000. Subtract your $600,000 loan and you may be able to access up to $200,000 in equity, assuming you meet all of your lender’s requirements.
How Do You Actually Access It?
In practice, accessing equity in your home usually involves borrowing against it. This can be done by increasing your existing home loan, taking out a separate loan secured against your property, or setting up a line of credit.
Let’s say you’re a homeowner who wants to take out a separate loan to purchase an investment property. The property you have your eye on is valued at $650,000, but you estimate costs like stamp duty, conveyancing and inspections will bring the total to $680,000.
If your lender is willing to finance up to 80% of the property’s value, you could borrow $520,000 against the new purchase, leaving a gap of $160,000 to cover the deposit and upfront costs.
The home you live in is valued at $900,000, and you still owe $500,000 on your mortgage. So, you have $400,000 of net equity in your home.
However, as only 80% of equity will be accessible, 80% of $900,000 is $720,000. When you subtract your existing loan balance of $500,000, you are left with $220,000 of usable equity.
That $220,000 could be used to cover the $160,000 needed for your investment purchase. Of course, you will still need to pass the usual loan approval checks. Your income, expenses and job stability will all come into play, and if you can’t show you can handle the repayments, the lender may not issue a further loan regardless of how much equity you have.
Options For Older Australians
There are other ways to tap into your home equity, such as a reverse mortgage or the Centrelink Home Equity Access Scheme (‘HEAS’). These are options are typically reserved for older homeowners who own their property outright or have very little debt.
A reverse mortgage generally allows you to borrow up to 20% of your home’s value, plus an additional 1% for every year older you are, over age 60. No repayments are required, interest is added to the loan, and this compounds over time. It is only when you sell your home, move into aged care, or pass away that you will be required to repay the loan.
The Home Equity Access Scheme is a government-backed scheme that allows older Australians draw extra pension payments by borrowing against the value of their property. You can choose how much to receive (subject to certain limits) and how you will receive these payments (an extra fortnightly payment, lump sum payments, or a combination of both). Similarly, you won’t be required to repay your loan until you exit the scheme, which usually happens when you sell your home or pass away.
The HEAS is generally available at a significantly lower effective rate of interest (currently, 3.95% per annum) than for a reverse mortgage (approximately 9%). However, access to funds via the HEAS is generally more restrictive than for a commercial reverse mortgage.
It is possible to access both the HEAS and a reverse mortgage, with both loans secured against the same property title. If you wish to do so, you will need to check your eligibility with both Centrelink and the loan provider.
How Can You Increase Your Equity?
A big part of it comes down to time and movement in the property market, but that is not to say you are powerless to act. Paying more than the minimum on your home loan reduces your balance faster and allows you to build equity sooner.
The same goes for refinancing your loan to a lower interest rate. This can leave you with more money in your pocket, but if you keep your repayments at the same level as before, you will find yourself whittling away at the principal of your loan at a faster rate.
Because unlocking equity in your home generally results in increasing your overall debt, it is important to have a solid plan in place. You will need to make sure you don’t overextend yourself financially, are able to meet repayments, and that the funds are put to productive use.
If you wish to discuss the prospect of accessing equity in your home, please contact us to arrange a time to meet with one of our financial advisers.