How a Home Equity Loan Works

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 in home loan 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 and more functional can be a preferable and cheaper alternative to selling your home and buying a new one, helping 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 an equity home loan to buy a car, it’s important that you adjust your repayments so you can 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

A home equity loan in Australia has both advantages and disadvantages. It’s important to do a cost/benefit analysis before you take one out to ensure 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, which 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 home equity loan calculator to work out how much you may be able to afford to borrow and repay, taking into account the current home equity loan rates in Australia.

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 can be 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).

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.