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How a Home Equity Loan Works

You build up equity in your home in two ways:

  1. 1 by making your regular home loan repayments, and
  2. 2 by your home increasing in value.

To calculate the equity you have in your home, simply subtract your outstanding home loan balance from your property’s current market value. For example, if your home is worth $800,000 and you owe $500,000 on your mortgage, you have $300,000 in home equity. This equity serves as collateral, providing your lender with the security they need to offer you an equity loan.
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The pros and cons of home equity loans

As with any financial decision, it’s essential to carefully consider the advantages and disadvantages of home equity loans before proceeding. Conducting a thorough cost-benefit analysis can help you determine whether a home equity loan is the right choice for your unique circumstances.

PROS

  • Access to Low-Interest Funds One of the primary benefits of home equity loans is the ability to borrow money at lower interest rates compared to other types of financing, such as personal loans or credit cards. By securing the loan against your property, lenders perceive home equity loans as less risky, allowing them to offer more competitive interest rates.
  • Potential to Increase Your Home’s Value If you use your home equity loan to fund home improvements or renovations, you may be able to increase the overall value of your property. Strategic upgrades, such as kitchen and bathroom remodels or adding an extra bedroom, can make your home more appealing to future buyers and potentially yield a higher return on investment when you decide to sell.
  • Opportunity to Grow Long-Term Wealth Using a home equity loan to purchase an investment property can be a savvy way to build your long-term wealth and secure your financial future. By becoming a landlord, you can generate rental income and benefit from potential capital appreciation as the property’s value increases over time. Additionally, owning an investment property may provide tax benefits, such as the ability to claim deductions for expenses related to the property.
  • Retention of Standard Home Loan Features When you take out a home equity loan, you may have the option to incorporate or retain useful features that are commonly associated with standard home loans. These may include offset accounts, which can help you reduce the amount of interest you pay on your loan, and redraw facilities, which allow you to access any extra repayments you’ve made if needed.

CONS

  • Increased Overall Debt One of the primary drawbacks of home equity loans is that they increase your overall level of debt. By borrowing against the equity in your home, you are essentially taking on more debt, which can have long-term implications for your financial well-being. It’s crucial to ensure that you have the means to comfortably manage the additional repayments before committing to a home equity loan.
  • Higher Repayments As a result of borrowing more money, your monthly repayments will increase when you take out a home equity loan. This can put a strain on your budget and may require you to adjust your spending habits accordingly. To mitigate the risk of interest rate fluctuations, consider locking in a fixed rate while rates are low, providing you with predictable repayments for a set period.
  • Potential Decrease in Long-Term Wealth While using a home equity loan for investments like property or home renovations can potentially increase your long-term wealth, using the funds for consumable purchases, such as a car or a holiday, can have the opposite effect. It’s essential to consider the long-term implications of your borrowing and ensure that you’re using your home equity loan for purposes that align with your financial goals.
  • Risk of Foreclosure As with any mortgage, defaulting on your home equity loan repayments can put your property at risk of foreclosure. If you fail to make your repayments, the lender may take legal action to seize your home and sell it to recoup their losses. This underscores the importance of borrowing responsibly and ensuring that you have a solid plan in place to manage your repayments.

Securing a Home Equity Loan: The Application Process

If you’ve determined that a home equity loan is the right choice for your financial needs, the next step is to navigate the application process. Here’s a general overview of what you can expect:
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Home equity loan FAQS

CAN YOU GET A HOME EQUIRY LOAN WITH BAD CREDIT?

Yes, it’s possible to get a home equity loan with bad credit, but it can be more challenging. Lenders are often hesitant to approve loans for individuals with poor credit due to the higher risk involved. However, some lenders specialise in providing loans to borrowers with bad credit. To improve your chances, you may need to demonstrate other positive factors such as a stable income, a low debt-to-income ratio or a significant amount of equity in your home.

HOW MUCH HOME EQUITY LOAN CAN I GET?

The amount of home equity loan you can get depends on several factors, including the current value of your home, the outstanding balance on your mortgage and the lender’s loan-to-value ratio requirements. Typically, lenders allow borrowers to access up to 80% to 90% of their home’s value, minus the outstanding mortgage balance. However, it’s important to note that individual lenders may have varying policies and criteria, so it’s advisable to consult with lenders directly to determine the specific amount you can qualify for based on your circumstances.

HOW DO I TAKE OUT A HOME EQUITY LOAN?

Start by assessing your financial situation and determining your borrowing needs. Research lenders and compare their terms, interest rates and fees. Gather all necessary documents such as proof of income, credit history and property information. Contact your chosen lender, submit an application and provide any requested documentation. If the lender approves your application, you must then review the loan terms and conditions, including the interest rate and repayment schedule. Finally, sign the loan agreement, receive the funds and start repaying the loan according to the terms.

WHAT IS EQUITY IN PROPERTY?

Equity in property refers to the difference between the market value of your property and the outstanding balance of any mortgages against it, representing the owner’s stake in the property. As the property’s value increases or the mortgage balance decreases, equity grows. Equity can be built through mortgage payments, appreciation in property value or home improvements. The more equity an owner possesses, the greater their financial leverage and potential benefits.

WHAT IS A HOME EQUITY LOAN?

A home equity loan is a type of loan that allows homeowners to borrow against the equity they’ve built up in their home. Equity is the difference between the market value of the home and the amount owed on the mortgage. With a home equity loan, borrowers can receive a lump sum of money to use for various purposes. The loan is secured by the home, meaning that if the borrower fails to repay, the lender can potentially foreclose on the property to recover the funds.

HOW DOES A HOME EQUITY LOAN WORK?

A home equity loan allows homeowners to borrow money against the equity in their property. The loan amount is determined by the home’s appraised value minus the outstanding mortgage balance. The borrower receives a lump sum and repays it over time with interest, using the home as collateral.

How do you get a home equity loan?

The experienced team of mortgage brokers at ARG Finance can help you choose the right refinance home equity loan for your needs. We have an Australian credit licence and we’ll take the time to understand your financial situation and goals before recommending a suitable home loan product for you. We can also help you with your loan application. We make buying a home and getting additional finance easy for our clients.

Contact us today to find out how we can help you.