Can you use your home equity to refinance or buy another property?
Home equity – it’s one of those financial terms that you’ve likely heard before, but might not quite be able to define. Don’t worry, you’re not alone.
If you’re a homeowner it’s a concept worth knowing about though, because it could affect everything from the home loan rate you receive, to your ability to refinance your loan or even purchase another property. Intrigued? Let’s get into it.
What is home equity and how does it work?
When you take out a mortgage, your lender maintains an interest in your home until your debt is completely paid off. Home equity reflects the portion you own outright — that is, the difference between what your home is worth and the outstanding balance on your mortgage.
As you pay off your loan though, the amount of equity you have will increase. The same will happen if your property’s value increases but, obviously, your equity will decrease if the value goes down.
To determine how much equity you have, you’ll first have to find out how much your property is worth. You can do this by hiring an assessor to conduct a formal valuation, using an online tool, or estimating using comparable sales in your area.
Example of home equity
Once you have your property’s value, working out your equity is as simple as subtracting the amount still owed on your mortgage. Here’s an example:
A few years ago Ella purchased an investment property which she recently had valued at $650,000. Over the years she’s also managed to pay down a fair bit of her mortgage, to the point where she currently owes her bank $275,000. As a result, she’s built up $375,000 worth of home equity.
How you can use home equity
So now that you know what home equity is, you’re probably wondering how it can actually be used. Well as we said above, if you’re a homeowner there are a few ways you might be able to use built up equity to your advantage, including:
- Purchasing another property
- Refinancing to a better rate
- Renovating your current home
- Investing in shares and managed funds
- Purchasing a car or travelling
Can you use your equity to buy another property?
If you’ve built up enough equity in your home, it doesn’t have to sit idle. You might be able to put it to use for other financial purposes, such as purchasing a new property. This is a common strategy among property investors looking to build their portfolio.
That said, banks will be reluctant to let you use all your equity to fund your purchase. Typically, they will only release around 80% of your home’s value minus the amount you owe to the bank.
To illustrate, let’s say you owe $300,000 on a property that’s currently valued at $600,000. To find out how much equity you have access to, you’ll first need to calculate 80% of your current property’s value.
- $600,000 x 80% = $480,000
Next you’ll need to take that value and subtract the amount still owed on your mortgage.
- $480,000 – $300,000 = $180,000
That means you can unlock $180,000 of equity to use for a deposit. To calculate how much you could borrow, multiply the usable equity by four. In this example, you’ll be able to borrow $720,000 using $180,000 worth of equity for the 20% deposit.
Just keep in mind you’ll also have to budget for other costs associated with purchasing a home, such as valuation fees, settlement fees, and stamp duty.
Can you use your equity to refinance?
You may also be able to leverage the equity in your home in order to refinance to a better home loan. This is because many lenders value ‘safer’ borrowers with higher built-up equity (and therefore a lower loan-to-value ratio) as they pose less of a risk than high LVR borrowers.
As a result, if you’ve managed to increase your equity and to lower your LVR below 80%, 70% or 60%, you might be able to switch to a new loan with a lower interest rate and take advantage of more affordable repayments.
What is negative equity?
Your home equity will change over time in response to housing market fluctuations and how quickly you pay down your loan. If you find yourself in negative equity, that means the amount you owe on your mortgage currently exceeds your property’s market value.
While this can be easy to avoid if property prices are rising and you’re making both principal and interest repayments, there are times where bad luck can strike.
For example, you might owe more than your home is worth if you bought at the top of the property cycle and the market is currently undergoing a correction. The same goes if you overpaid for a property and not enough time has passed for equity to build up.
Why is negative equity a problem?
Negative equity is mainly a problem if you intend to put your property on the market. Selling a home with a mortgage involves paying off the remaining balance, and if the amount your home is worth isn’t enough to cover it, you’ll have to make up the difference.
Depending on your circumstances, that might mean drawing from your savings or even selling other assets. Your lender might also decide to actively monitor your finances to make sure you’re not shirking your loan obligations.
If the final payout falls short and you can’t come up with the necessary funds to cover your debt, your lender will turn the issue over to their mortgage insurer. After paying out the shortfall to your lender, they will then commence the process of recovering the amount you owe.
If you’re thinking about using the equity you’ve built up to switch to a better rate then get started by checking out the great refinancing offers in the table below, reach out and let’s talk
Source: Niko Iliakis
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