What is Home Equity?
A home equity loan, also known as a line of credit, is a great option for borrowers in Australian. If you are ever in need of some extra cash, whether during an emergency or other purposes, your home equity can be used as a source of low-cost funds to help you achieve those personal goals.
Many parts of Australia’s property market took off in 2014 and 2015, which is not a hidden fact. However, the prime question is, “what does this mean for homeowners?”
For homeowners, the catch here is that your home equity is actually gold mine that you are sitting on and the funds from it can be tapped into to achieve your personal wish-list of travelling the world, or other things in your bucket list.
Calculating Home Equity
Let us try to understand home equity with a simple example
Suppose, you own a house that is valued at $600,000 and the remaining mortgage on it is $250,000. So, your equity, which is the amount that is obtained after subtracting the remaining mortgage from the total value of the house will be $350,000.
In the same manner, if suppose your property is valued at $1,050,000 and mortgage owed is at $700,000, then the equity would be $3,50,000. The image below illustrates this example better.
However, just because homeowners have$350,000 available as equity, it does not mean that they can access or use the entire amount. Just like normal mortgages, a costly Lenders Mortgage Insurance (LMI) will apply to you if you borrow more than 80 per cent of your home’s value.
To avoid the risk of having to pay a costly LMI, here is a formula that can help you to work out the amount of usable equity for your home.
Suppose, the value of your home is $500,000 and the the amount of debt that you owe on it is $350,000.
So, your home’s potential usable equity can be calculated as follows-
($500,000 X 0.80%)- $350,000 = $50,000
Hence, the equity that you can safely tap is the difference of $50,000.
However, keep in mind the fact that you would 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.
Accessing Home Equity
Many people around the world assume that they can only access home equity if they are plan on upgrading to a newer and better property than the one they are living in.
Nonetheless, If the value of your home has risen, you as a homeowner should be aware that it is possible to tap into equity. This can be done by topping up or redrawing on your home loan and there can be a number of good reasons to do it.
Home loan interest rates are normally lower than other types of credit, like personal loans or credit cards. This is why, using home equity rather than other types of credit to fund major purchases may give you the advantage of a very competitive interest rate.
However, if you, at some point of time, decide to switch banks and refinance, then there will be costs involved in refinancing. These costs may include application fees, valuation fees, settlement 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.
Uses of Home Equity
As long as you can comfortably afford the repayments for the larger home loan, you are free to use home equity as you choose. The money can also be used as a deposit on an investment property, thus giving you the benefit of rental income.
If you are thinking of using your home equity to fund a holiday or something more short term, then ensure to keep that debt separate to your main home loan with a split loan. Also ensure that you pay it off as quickly as possible so it does not extend over a long period of time. This will help to lower the total amount of interest that a homeowner will have to pay.
Is Cashing-In Home Equity a Risk?
This is a common question with those who want immediate money through this route. So, the answer is that it may not be a risk for you, but for the lender it is, or at least he perceives it that way for multiple reasons.
One of them being, the amount that you trying to access. It is large. Further, the amount is either transacted directly to your account or into a line of credit for immediate access, which limits the lender’s control over its usage. This means that you might choose to use it for something other than the intended purpose.
Another thing that you fail to see is the reason why you are going for equity–as per lenders, you require these funds because your lifestyle requirements exceed your means. This is definitely a risk for you as well as the lender, even if you do not see it that way.
Some of the other risks involved are:
- You might have to pay higher amount as repayments.
- A breach of terms and conditions might require you to sell your home to repay the loan.
- If the value of your property does not increase as expected, or if it depreciates, then you might end up with less (equity) money when you sell your home.
Over to You
It is always wise to weigh the risks and benefits. Work out what exactly do you need the money for. As you proceed with your list, look at and ask yourself,
“Is whatever that I am gaining worth what I am giving up?”
“Can I to postpone my home equity until I absolutely require it?”
“Is this the only way for me to meet my financial needs?”
“Will I lose out on my pension and benefits?”
It can be a smart choice to use your home as a source of revenue in urgent situations. But, you need to be careful with the way you calculate the numbers and anticipate your future cash flow before signing off the final deal.
Home equity is probably not a good idea if used for recreational expenses, a vacation, or for paying your routine monthly bills. However, they can be real lifesavers for you whenever you are saddled with important and unexpected financial obstacles such as hospital bills. So, ask yourself,
Do I really need to cash-in my home equity?
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 in organizing 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.