Just what is equity anyway? How do you figure out how much you’ve got and then make the most of it? Get to grips with your equity options with our simple guide.
Run the numbers
If you own a property, whether it’s an investment or a home, your equity is the current agreed value of your property, minus any loans you have secured on it. So let’s say you own a three-bedroom house and it’s now worth $650,000. Your current mortgage balance is $450,000. So the equity you have in your house is $200,000.
Of course, one way to benefit from your equity is to sell and pocket the difference or buy another property. But if you refinance instead, a bank may offer you an additional or larger loan. How much you can increase your borrowing will depend on quite a few things – from your financial position to what you plan to use the money for.
What’s it worth?
When you’re arranging a mortgage, your lender will have the property valued before agreeing the amount you can borrow. So before you start making plans, it’s a very good idea to get a clear idea of how your property valuation is going to make a difference to your borrowing power.
If you do have $200,000 in equity, you may not be able to borrow against all of it. For many lenders, 80% is the most you can borrow against the value of property. This is called the loan to value ratio (LVR). For a $650,000 property, your maximum mortgage would be $520,000. Loans with a higher LVR can sometimes be arranged, but for a price and it’s called LMI – or Lender’s Mortgage Insurance. This is a one-off premium you’ll pay to protect the lender in case you stop making repayments. The larger the loan, the bigger the premium.
Lose the debt
Now that you’ve got a handle on your borrowing potential, what are your options for making the most of your equity? If you have any credit card balances or personal loans you may want to use your equity to settle these as they normally attract a higher rate of interest. This is known as debt consolidation.
Getting rid of debt can certainly save you money in the long term. But by using your equity to buy an investment property you could actually be making money instead. You might think you need a lot of wealth to own multiple properties but this isn’t always the case. Investing on a budget is possible if you get the right finance in place with help from an experienced broker.
Renovating your home can be a very positive and rewarding way to put your equity to work. Refinancing is only one of the ways to fund a renovation project, but it can be a very affordable solution. A good broker can help you understand how construction loans work and talk to you about overcapitalising – spending more on the project than you’re adding in value.
Help the next generation
If your kids are struggling to save a deposit for a home, using equity in your property as security for theirs is one option and can help them buy their first home sooner. It helps to get good advice from a broker who can tell you exactly what’s involved and help you find a suitable lender and mortgage. You should also seek independent financial, investment and taxation advice.
Have you refinanced to access your equity and what did you use it for? Tell us about your experience in the comments below.