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Explaining home equity

You may have heard of people using the equity they have in their home to fund their investments. Here we’ll look at what equity is and how you can use it.

After arranging the best home loan for your piece of paradise, and regularly making loan repayments, there has be a pay-off, right? Apart from feeling good about yourself, and reducing your debt levels, the major benefit of paying off your mortgage faster is that you start to own more of your home sooner.

That’s why “equity” is the homeowner’s best friend.

Simply put, equity is the difference between the value of your property and the amount you owe on your loan. Not only does growing your equity increase the value of your assets, it can be used for other purposes, such as paying for home improvements, a car or a holiday, clearing credit card debt, or even getting a loan for other investments.

How does home equity work?

In simple terms, equity is the amount of money you would have left over if you sold your home and used the money to pay off your home loan. Let’s say you owe $450,000 on a property that an independent valuer says is worth $600,000. This means the amount of equity you have in your home is $150,000.

Equity levels vary as the property market changes, too. For example, if the value of your property goes from $600,000 to $650,000, then you have an extra $50,000 in equity.

To gain access to this equity you might look at refinancing, which is always a worthwhile option as circumstances change. See here to find out more about refinancing.

Why is my equity important?

Most people would agree the equity they have in their home – the part they own – is their largest financial asset. The more equity you have, the more money you will get when the time comes to sell your home.

It’s why most financial advisers believe homeowners should strive to pay off their home loan before they retire; anyone would prefer to not have their retirement income taken up with mortgage repayments. They may be forced to continue working or move to a smaller, less expensive property.

The more equity you have, the more financially secure you will be – and the more life options you’re likely to have, too.

How can I use the equity in my home?

Most lenders allow you to access your equity through a redraw facility. By paying off the principal on your loan (as well as the interest), you create a pool of money that you can use to fund major purchases or pay any debts that have a higher interest rate, such as those on a credit card.

Another option is a “line of credit”, which allows you to draw down on the equity you’ve built in your home. It’s similar to having a large bank balance at your disposal.

For example, you may have $180,000 in equity that you can access through a line of credit. You then spend $60,000 renovating your home. Lenders will only charge interest on that $60,000, while the remaining $120,000 costs you nothing until you use it.

You will need to make regular repayments, though some lenders allow you to capitalise these onto the amount you borrow. This means you add the repayment onto the amount you owe, up to the limit the lender sets on your line of credit. Most lenders prevent you from accessing any more than 80% of your equity.

Your lender will usually charge a fee for setting up and maintaining your line of credit. This fee is typically between $120 and  $600 per year. Read more about a line of credit feature here.

Those over 65 might also be able to take out a reverse mortgage, which allows them to borrow money against the equity in their home. They can receive this money in instalments or as a lump sum.

How do I increase my level of equity?

The simplest way to increase your equity is to keep making your home loan repayments. Top-up your loan balance when you can and take advantage of any early repayment facilities that your lender provides.

Another option is to have an offset account – an everyday savings account linked to your home loan. The funds in this account offset the amount you owe.

All of these things will reduce the amount of interest you pay, while making a bigger dent in your loan principal. They will also increase the equity you hold.

What is a home equity loan?

Many people choose to use their equity to increase their investment portfolio. You may do this through a redraw or line of credit and investing, say, in shares or managed funds.

Another way is by getting a home equity loan. This is a loan that allows you to use the equity in your property to use as a deposit on a second property.

All investment options come with risks. A better use of a home equity loan is to pay off any credit card debt, which tends to come with a much higher interest rate.

Investors often use their equity to “gear” their investments. This means they may be eligible to receive higher returns from their shares and investments. You should speak to a tax professional before doing this.

What to do next

There are several ways you can use the equity in your home to your advantage:

Calculate how much you can save through refinancing
Have a chat to one of our home loan specialists

This information is general in nature, and you should always seek professional advice when making financial decisions.

This information in this article is general only and does not take into account your individual circumstances. It should not be relied upon to make any financial decisions. uno can’t make a recommendation until we complete an assessment of your requirements and objectives and your financial position. Interest rates, and other product information included in this article, are subject to change at any time at the complete discretion of each lender.

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Alexi Neocleous

With over 20 years experience, Alexi has written extensively a wide cross section of financial topics. These topics range from financial planning, mortgages, property commentary and all points in between.

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