Your home equity could offer a source of low cost funds that can be used to achieve personal goals.
It’s no secret that the property market took off in 2014 and 2015 in many parts of Australia. So what does that mean for home owners?
The bottom line is that you could be sitting on a gold mine also known as home equity, and funds you may be able to tap into to achieve your personal wish-list. Have you always wanted to be a property investor, or do you long to travel the world and tick things off an ever growing bucket list like me?
By tapping into your home equity, these dreams may be possible sooner than you think.
What is home equity?
Home equity is the difference between the market value of your property and the size of your home loan. Over time, if property prices rise (also known as capital growth) and your loan is steadily paid off, home equity should increase with each passing year.
How to calculate home equity
Let’s say for example, that Bill and Sue bought their Sydney unit valued at $500,000 in late 2014. If their property has risen in value by the 11.5 per cent growth rate recorded last year, the apartment could currently be worth $557,500 ($500,000 x 1.115). Assuming they have a mortgage of $350,000, Bill and Sue could have home equity of $207,500 ($557,500 less $350,000).
However, just because they have $207,500 in equity doesn’t mean they can access or use the entire amount. Just like with normal mortgages, if you borrow more than 80 per cent of your home’s value you may have to pay costly Lenders Mortgage Insurance (LMI). To avoid LMI, you can work out your home’s ‘useable’ equity with this calculation:
Your home’s value x 0.80% = $400,000
The amount of debt owing: $350,000
Your home’s potential useable equity: $400,000 – $350,000 = $50,000
TIP! You will still need to prove to your bank or lender that you can afford the higher loan repayments once the equity is added to your loan.
A source of low cost funding
Many people believe they can only access home equity when they sell their home to upgrade to a different property. However it is possible to tap into equity without having to pull up stumps. If the value of your home has risen it may be possible to harness your home’s equity by topping up or redrawing on your home loan. And there can be good reasons to do this.
First, home loan interest rates are normally lower than other types of credit, like personal loans or credit cards. Even better, at present, mortgage interest rates are at record lows. By using home equity rather than another type of credit to fund major purchases, you may gain the advantage of a very competitive interest rate.
Are there costs to access home equity?
If you want to borrow more than 80 per cent of your home’s value, then LMI might be a cost. If you decide to switch banks and refinance, then there are costs involved in refinancing, which may include application fees, valuation fees, settlement fees, mortgage stamp duty fees and any exit fees if they apply.
You need to check with your bank or mortgage broker what fees apply if you top up your current mortgage. They can be free with some home loan products, while other banks can charge upwards of $450 as a one-off establishment fee.
What can home equity be used for?
As long as you can comfortably afford the repayments for the larger home loan, you are generally free to use home equity as you choose. That means being able to kick some important personal goals – like funding quality education for your children, renovating the kitchen or adding another bedroom (which can further boost the value of your home). Or the money could be used as a deposit on an investment property (giving you the benefit of rental income to repay the loan), to buy a new car or send your family on that overseas holiday you’ve been dreaming about.
TIP! If you’re using your home equity to fund a holiday or something more short term than the purchase of an investment property or a major renovation, keep that debt separate to your main home loan with a split loan and make sure you pay it off as quickly as possible so you don’t extend the debt out over a long period of time. This will help to lower the total amount of interest you will pay.
How do I get started?
Using home equity and increasing the size of your home loan is a big financial decision, so it’s important to seek expert advice. Speak to your mortgage broker about your plans, and they can help organise a valuation of your property by your lender, which is an important place to start.
Your broker can then help you work out how much equity you have, how much you can comfortably afford to access, what’s the right course of action and how to structure it within your home loan.
Have you used home equity to achieve your goals? Tell us your experience in the comments below.