If you have been wondering how to unlock home equity for renovations, further investment, or even wealth management, we are here to help.
But before we dive into using home loan equity for investment, renovations or anything else, let’s start with the basic question:
What is Home Equity?
In short, home equity is the difference between your property’s current market value and the remaining balance on your home loan. It refers to the portion of your property’s financial value that you own outright, i.e., not through a bank loan.
Home equity: an example
Let’s say you purchase a house for $500,000 with a $400,000 mortgage loan. Your home equity is $100,000.
Overtime, you pay off $50,000 of that loan through regular repayments. Now your equity is $150,000.
If, during this same time, your house is now worth $550,000, your equity increases accordingly to $200,000.
In other words, the market value ($550,000) minus your outstanding mortgage ($350,000) gives you your home equity ($200,000).
Home equity builds over time
The value of your home and thus your equity in it can fluctuate over time based on various factors, such as your ongoing loan repayments and changes in the real estate market.
The more you pay down your loan, the more you gradually increase equity in the property. Similarly, the more your property appreciates, the greater your equity as the gap between its market value and your existing loan widens.
The importance of home equity
Why does home equity matter? There are a few important reasons.
1. Value of your asset
Equity represents a valuable financial asset that can potentially be tapped into for other financial goals. As your equity grows, you can contribute to your long-term wealth building.
2. Borrowing power
Homeowners can borrow more money against their equity through home equity loans and possibly access lower interest rates.
3. Opportunities for investment
Home equity can be used to invest in other properties or fund renovations or other work, which may further increase the property’s value.
How to Unlock Equity from Your Home Loan
Unlocking home equity through refinancing
Refinancing is one way of unlocking your home equity. It allows you to leverage your equity to take out a new or larger loan to use strategically for other investments or personal needs.
Unlocking home equity without refinancing
There are two alternative ways to utilise home loan equity for investment or other needs, such as renovations. An equity redraw facility allows you to withdraw extra repayments made on your mortgage giving you access to extra funds at the cost of increasing your loan balance. Alternatively, you can take out a separate loan or line of credit (called a home equity loan) using your existing equity as bank security. The benefit of this method is that you are only charged interest on the money you actually use.
The process to unlock home equity
In brief, to unlock home equity you will need to undergo:
- A loan application; and a
- A professional property valuation
Always keep in mind potential costs, such as refinancing fees and potential Lenders Mortgage Insurance (see below for more information). We recommend seeking professional financial advice when weighing the benefits and costs of accessing home equity to ensure your strategy aligns with your long-term financial goals.
Calculating Accessible Home Equity
Understanding the Loan-to-Value Ratio (LVR)
The Loan-to-Value Ratio (LVR) is a critical factor in determining how much home equity you can access. You can calculate it by dividing your remaining loan amount by the value of the property.
In general, most lenders consider an LVR of 80% or higher as risky and thus requiring Lenders Mortgage Insurance.
Let’s calculate home equity using an example: If your home is worth $500,000, then 80% is $400,000. If you owe $300,000 on your current mortgage your usable equity is $100,000 (i.e., $400,000 minus $300,000).
Note that the final calculation can vary depending on the approval and criteria of your particular lender.
Unlocking Home Equity for Renovations
Home equity can be a powerful tool for funding home renovations. In addition to improving the comfort, functionality and/or aesthetics of your home, this often cost-effective form of financing helps increase your property value as well.
To maximise the benefits of your value-adding renovations, consider how your chosen upgrades will enhance the appeal of your home to potential buyers. For example, you may want to modernise and upgrade your kitchen, improve the storage and fixtures of your bathroom, expand your living space, improve the energy efficiency of the space, or even enhance the cosmetic aesthetic of your home.
If you are going to unlock home equity to fund renovations, make sure you don’t overcapitalise, i.e., spend more money than the value you are adding.
Always consider the cost of materials and labour involved in your renovations, research and compare the increase in property value with similar renovations in the area, and stick to your predetermined budget.
How to Use Home Equity for Renovations
There are a few loan structuring options available. Each has its own pros and cons, so make sure to reach out to the Loan Monster team for tailored advice.
- Split Loan: Split loans separate the renovation portion from your main mortgage to assist with managing repayments.
- Construction Loan: These loans are ideal for major projects as they offer staged payments as the work progresses.
- Line of Credit: This financial solution offers flexibility by allowing you to draw the funds you need as you need it.
- Cash-Out Refinance: This is the simplest option and includes increasing your mortgage balance by releasing equity for cash up front.
Unlocking Home Equity for Property Investment
An alternative form of wealth building is using your home loan equity for investment in additional properties.
You can leverage equity from your first property to fund deposits for additional properties – this is a popular strategy for building a property portfolio and allows investors to access funds without saving cash.
Of course, there are risks and benefits with this approach. Benefits include faster portfolio growth, potential capital appreciation, increased rental income, and various tax advantages. But the risks involve increased debt, market volatility, and a greater financial commitment.
Always consider your financial situation and future plans before unlocking home equity for property investment. Remember that accessing existing equity increases your loan balance can lead to higher repayments or extended loan terms. Additionally, fluctuating interest rates, additional costs, and the risk of overleveraging should be taken into account.
How to Use Home Equity for Investments
There are a number of loan structuring options available depending on your needs. Once again, we recommend speaking with a loan specialist here at Loan Monster for custom advice.
- Line of Credit: This allows for a flexible access to funds, with interest to be paid only on the amount you use.
- Cross-Collateralisation: With this facility both properties secure one loan in a simplified financial arrangement.
- Separate Loans: With this option you keep both loans independent and simply use equity from the first property as a deposit for the second.
- Interest-Only Loans: An interest-only loan maximises tax benefits and cash flow for investment properties.
Consult with your local Fremantle mortgage broker: Loan Monster
Given the complexity, risks, benefits, options and considerations involved in unlocking your home equity for renovations, investment or other purposes, professional advice is the key.
Loan Monster, the leading and local Fremantle mortgage broker is here to help. Our team of experienced experts can help analyse your financial situation and goals, ensure you understand the implications of unlocking home equity and utilise the funds strategically, and help guide you towards the most suitable loan products and financial facilities to enable you to achieve your long-term objectives.
Whether you know exactly how to unlock home equity and have done it before, or are still wondering how home loan equity for investment and renovations work, give Loan Monster a call today.
