What is Equity and How Can I use It?

If you're a homeowner, it's likely that you've accumulated equity in your home over time. Owning property is widely regarded as one of the most effective methods for building wealth. While the property itself holds value, the true wealth lies in the equity it accrues. Equity represents the portion of your home that you truly own, increasing as you steadily pay off your mortgage or as your property value appreciates over time.

This equity can serve as a valuable resource that you can borrow against to fund things such as purchasing an investment property, renovation projects, buying a new car or achieving other personal goals.

What is Equity?

Home equity represents the difference between the market value of your property or home and the outstanding balance on your home loan.

For instance, if your home is currently valued at $800,000, and you owe $500,000 on your home loan, your equity amounts to $300,000.

If you’ve been paying off your home loan, and particularly if properties have increased in value in your area, you will likely have built up some equity.

It’s important to note that lenders commonly permit borrowers to access up to 80% of their property's value, a benchmark often referred to as Usable Equity.

What is Usable Equity?

As the name suggests, usable equity refers to the portion of equity in your home that you can readily access and use for borrowing purposes. In common home loan scenarios, you're typically permitted to borrow up to 80% of your property's value without the requirement of paying Lender’s Mortgage Insurance (LMI). This rule may still hold true even as your property value appreciate over time. However, to accurately determine the specific amount of usable equity available to you, your property will need to undergo a valuation. It's advisable to consult with one of our home loan specialist to better understand your borrowing capacity and explore your options.

Determining your usable equity is simple: just calculate 80% of your property's current value and subtract the remaining balance on your mortgage. This straight forward calculation reveals the amount of equity that you can tap into to pursue your financial goals.

For example: John and Carol purchased their family home for $650,000. At the time, they borrowed $520,000 (80%) from their lender, and provided a deposit from their savings of $130,000 (20%).

2 years later, their property has increased in value to $800,000. They have also paid down their loan to $500,000.

This has given them equity of $300,000, taking the current value of the property, and subtracting what they still currently owe on it.

Their home loan provider will allow them to borrow up to a total of 80% of the current value of the property without needing to pay LMI. This means that they may be able borrow additional funds referred to as usable equity, provided they have sufficient income and approved financial circumstances for additional borrowing from their home loan provider.

Their usable equity was calculated by making the following 2 calculations:

By using the two simple calculations above you are able determine that in this scenario the usable equity typically allowed by lenders is $140,000.

How Can I Use Home Equity?

There are many reasons why you might want to access equity in your home. Lenders will often let you tap into your home equity to use as collateral for new loans. This is a very common strategy for property investors. Done right, it can yield great results – as long as you're aware of the risks. Below are a few common ways to use your home equity:

• Use your equity as a deposit on an investment property

  One of the more commonly known ways to use equity is when you're wanting to purchase an investment property. Instead of going through the process of saving up for a deposit or selling your current home, you can tap into the equity of your existing property and cross securitise the amount of your deposit required to purchase your investment property. Your lender will likely request a valuation to gauge your property's market value accurately. This valuation serves as the basis for determining your usable equity. However, it's important to note that just because you have for instance, $140,000 in equity, doesn't necessarily mean you should access all of it for this purpose.

• Refinancing your home loan

  You might find that you can leverage your equity to refinance your current home loan, potentially securing a more favorable deal, such as a lower interest rate. This is because lenders often favor borrowers with a lower Loan to Value Ratio (LVR), considering them less risky. By increasing your equity and consequently reducing your LVR, you may qualify for refinancing to a new home loan with reduced interest rates and, subsequently, lower monthly repayments.

• Use your equity to renovate your current home

  Naturally, you might be considering using the equity tied up in your current property to undertake some renovations. Many people decide to tap into their equity for renovation purposes. Some are looking to enhance the value of their property, while others find themselves needing renovations due to life changes. For instance, perhaps you might want to add a bedroom to the property because you’re about to start a family or you have a child and want to have a second, and so on. So you’re changing the property to suit your current life stages.

• Use your equity for other investments

  Just because you've accumulated equity in your property doesn't mean you're restricted to keeping it tied up in real estate. In fact, if you're looking to maximise the potential of your equity, diversifying into different asset classes could be a worthwhile consideration. Some people are interested in leveraging their equity for various investment purposes. This falls under the broader category of wealth creation. When it comes to utilising your home equity for investments, you don't need to limit yourself to just property. You could explore opportunities in the stock market, invest in bonds, or delve into a variety of managed funds. Each option carries its own level of risk, but it highlights the versatility of leveraging your home equity to enhance your financial portfolio. With these possibilities in mind, leveraging your home equity to support your wealth creation strategy can prove to be a savvy and rewarding strategy.

As always, it's crucial to consult with your financial advisor before making any decisions. They can carefully assess your risk tolerance, objectives, and goals to ensure that your strategy aligns with your overall financial plan.

In Conclusion, your home equity is the difference between your property's current value and your outstanding loan balance and can be leveraged for various purposes. Lenders often permit borrowing up to 80% of your home equity, depending on your ability to service the loan. Investing, whether in property or other asset classes, is a popular method to maximise equity. Additionally, many homeowners use their equity to finance renovations or home improvements.

It’s important to note that equity isn’t free money. You are accessing your equity by increasing the principal loan balance against your property, and you still have to repay this over the agreed loan term.

If you are considering tapping into your home equity, book a free of charge appointment with one of our brokers to find out how much equity you have in your home and what options you have available.

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