How home equity loans work

You build up equity in your home in two ways:

by making your regular home loan repayments, and

by your home increasing in value.

You can calculate your equity by subtracting the amount you owe on your home loan from the current value of your home. For example, if your home is worth $800,000 and your home loan balance is $500,000, you have $300,000 worth of equity in your home. You can borrow against some of that equity because it provides your lender with the security they need.

Uses for home equity loans

You can use a home equity loan for a variety of purposes, including:

a deposit on an investment property

Many lenders will require you to have at least a 20% deposit when buying an investment property. Instead of having to save and come up with that deposit, you can unlock the equity you have in your home instead.

renovating your home

Most people find that their housing needs change over time. For example, when couples have children. Renovating your home to make it bigger can be a preferable and cheaper alternative to selling your home and buying a new one. It will help you to avoid selling costs such as real estate agent fees and buying costs such as stamp duty.

debt consolidation

Debt consolidation involves combining higher-interest debt that you may have (like credit cards and personal loans) into your lower-interest home loan. This can help to make all your debts easier to manage. It can also result in you paying less interest.

to buy a car

Home loan finance is usually cheaper than car loan finance. However, if you do use a home equity loan to buy a car, it’s important that you adjust your repayments so you pay it off within seven years. If you don’t, you could still be paying interest on your car for years afterwards.

The pros and cons of home equity loans

Home equity loans can have both advantages and disadvantages. It’s important to do a cost/benefit analysis before you take one out. You need to make sure that the benefits outweigh the costs.

Pros

  • They give you access to low-interest funds.
  • You could increase the value of your home if you use a home equity loan for a renovation.
  • You could grow your long-term wealth and help to secure your financial future if you use a home equity loan to help you buy an investment property.
  • They allow you to retain or incorporate potentially useful standard home loan optional features like offset accounts and redraw facilities.

Cons

  • You will increase your overall level of debt if you take out a home equity loan.
  • Your repayments will increase. It may be worthwhile to lock in a fixed rate while interest rates are low.
  • If you use your home equity loan to buy a car or pay for a holiday rather than for an investment property or renovation, your long-term wealth will decrease.

Home equity loan FAQS

What is lenders’ mortgage insurance (LMI)?

LMI is insurance that protects lenders if borrowers don’t make their repayments. It is a cost paid for by borrowers. The cost of LMI can be more than $10,000 on an average-sized home loan in Australia ($500,000).

What is a loan to value ratio (LVR)?

Lenders calculate LVR as part of assessing your home loan application. It is the value of the loan expressed as a percentage of the value of your home. For example, an 80 LVR means that your loan amount is 80% of the current value of your home. Most lenders will require you to pay for LMI if your LVR is more than 80%. This protects them if you don’t make your repayments.

If you’re taking out a home equity loan, and your LVR rises above 80%, you will most likely have to pay for LMI. It will usually be added on to your loan balance.

How much can I borrow with a home equity loan?

This depends on your individual financial situation and how much you can afford to repay. It also depends on the lending policy of your lender. Different lenders will have different home equity loan terms and conditions that they are prepared to accept. For example, some may be prepared to lend to a higher LVR than others.

You can use our online loan repayment calculator to work out how much you may be able to afford to borrow.

What is usable equity?

Your usable equity is the difference between the lender’s maximum LVR and the amount you owe on your home loan. This is best explained using an example.

Example:

If the maximum LVR that your lender will accept for a home equity loan is 80% and your home is currently worth $800,000, the maximum you will be able to owe is $640,000 (i.e. 80% of $800,000). If you already owe $400,000 on your home loan, then your usable equity would be $640,000 less $400,000 (i.e. $240,000).

How do you get a home equity loan?

Our experienced team of mortgage brokers at ARG Finance can help you to choose the right 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!