If you own property, it’s likely you’ve already heard the term ‘equity.’ Here we outline what it is, how you calculate it and how it can help you with your next property purchase.
What is equity?
Equity is the difference between the market value of your home and the current balance of your home loan.
Equity typically grows over time due to your property increasing in value and/or the balance of your home loan decreasing.
How much of the equity in my home can I release?
The amount of equity available for release is determined by –
- The current value of your home – this will be ascertained by a lender valuation
- The current balance of loan/s secured against your property (i.e. your home loan)
- Lending ratios – typically you can borrow up to 80% of the property value, but this can depend on the lender and in some cases, the type of property you have
- Your capacity to repay this new loan – when you ‘release equity’ you’re essentially taking out a new loan (or increasing the limit on your existing loan). You’re simply using the increased value of your property to help secure the additional lending. Therefore, before a lender will agree to this, you need to be able to demonstrate you can meet the additional monthly repayments associated with higher debt levels.
How do I release equity?
Equity can be released by increasing the limit on your current loan, but more commonly its done as part of a refinance application.
It really depends on the valuation, the amount of equity you’re hoping to release and the reason for wanting to increase your overall debt.
What can I release equity for?
Releasing equity can be a way to help you achieve something you’re already trying to do, not a means to access funds that you then need to find a way to spend.
Some of the common reasons homeowners release equity as part of a refinance, include:
- to pay out a high-interest rate personal loan and/or credit card debt*
- to make non-structural improvements to your home (things like painting, landscaping, installing double-glazed windows etc)
- to provide funds to purchase a motor vehicle/motor home *
- to invest into the share market (this is normally at the recommendation of an accountant/financial planner)
* Careful consideration needs to be given here to ensure you don’t end up paying additional interest over the life of the loan. Releasing $25,000 equity to pay off your high-interest-rate car loan may you interest (due to a lower interest rate), but not if you then take 30 years to pay the $25K off!
How can I use equity to purchase an investment property?
The easiest way to explain this is with an example.
Let’s say you want to buy an investment property for $500,000.
You estimate there will be $25,000 in purchasing costs (things like stamp duty and legal fees). So all up, you need $525,000 to purchase this investment property.
A lender will typically allow you to borrow up to 80% of a property’s value. This means you could have a loan of $400,000 secured by your new property only.
But to purchase this property, you need $525K. And with a loan of $400K secured by the new property solely, you’re $125K short.
(It is possible to borrow more than 80% of the property value with Lenders Mortgage Insurance (LMI), but we won’t go into this here. You can find out more on LMI here.)
Let’s see if there’s enough equity in your current home to avoid contributing $125K cash towards the purchase.
Your home is valued at $900,000 and your existing home loan has a balance of $450,000.
If we apply the 80% lending ratio to your owner occupier home, and take into account the balance of your current home loan, it shows we have $270,000 of available equity here:
(900,000 x 80%) – $450,000 = $270,000.
This shows you have sufficient equity to help secure the additional $125K required.
Providing you can demonstrate capacity is evident to meet repayments on total new lending of $525K, in this example, you could borrow all the funds required to purchase this investment property without having to contribute any cash.
By providing your own home as additional security to the lender, you’re reducing the Loan to Value Ratio on your new loan/s. This can reduce the cash contribution required for a purchase (in this example $0 cash is required). And in some cases, it also helps you to secure a lower interest rate with your chosen lender.
If you’re keen to explore your own options for releasing equity, please give us a call on 02 6286 6501.
