If you own your own home and have been making repayments for some time you’re likely to have built equity, or value, in the property. Depending on how much this is, you could use your equity to secure a home loan, buy an investment property, or renovate your home.
Sometimes the concept of property equity and how it is calculated can be a little confusing. So to help you on your way, here’s a no-fuss guide to what it is and how it can be used to take a step-up the property ladder.
Equity is the difference between the current market value of your property and the amount you still owe on your mortgage or home loan.
For example, if your home is worth $850,000 and you still owe $200,000 on your mortgage, the equity would be $650,000. As you can see, if property prices are rising and you have been making all your mortgage repayments, the equity (or value) in your home could be a considerable amount.
Unfortunately home loan providers don’t allow you to use all the available equity in your property to secure a loan - their calculation is based on ‘usable’ equity.
Usable equity is the portion or percentage of your total equity that a lender will allow you to access. The standard calculation they use is to work out 80% of your total property value and subtract the remaining balance of your home loan.
This is to protect themselves in case you can’t afford the payments on the new loan. Some lenders may allow you to access more of your available equity if you agree to pay lenders mortgage insurance (LMI), but this does make the loan more expensive for you.
Example: Using the values in our example above, this is what your usable equity would be:
80% of $850,000 = $650,000 – $200,000 = $450,000 usable equity.
Let’s now answer a common question: can you utilise usable equity to buy a house with no deposit?
The short answer is, yes - the equity in your home can be used instead of a cash deposit to buy a property. The equity in your existing property is essentially acting as security on the new debt.
This will depend on a number of factors, including if your property has risen in value enough to provide you with enough equity. You also will have reduced what you owe on your home loan, by making regular repayments toward the principal and interest portion of the loan.
Ultimately your lender will calculate your usable equity and assess your borrowing power before deciding if you are a suitable candidate for a new loan.
There are three main options when it comes to using the existing equity in your home to buy property:
As the name implies, a home loan top up simply increases your existing home loan limit, and essentially increases the debt on your current home loan. Once approved, your existing lender will simply deposit the agreed sum into your account as cash, and you use these funds to purchase the new property.
Be aware that your monthly repayments will increase, so you will need to be able to afford this. Your loan term is also likely to increase, meaning you will be paying back the loan for longer. This option may not be available on all home loans, so check with your lender to confirm this.
Use a mortgage repayment calculator to work out how much you can afford, and what your repayments could be.
Cross-collateralisation is a strategy where your existing property is used as security or collateral, and it gets added to the new property’s loan. There are two mortgages or home loans in this scenario:
The pro of this option is you save on fees, but if you cannot make repayments, both properties can be repossessed. It is also more complicated if you decide to sell one property, as you have to apply for a fresh loan for the one you are keeping.
A supplementary loan account is simply another home loan specifically to finance your new property. The big advantage of this is that you can choose loan features - like a low-rate, interest-only product that minimises your monthly repayments. This option also makes sense if you want to limit your outgoings and leverage a rising market.
But is using equity to finance your next property a good idea?
In most cases using equity is a great way to leverage and a popular option to invest in the property market immediately, without the requirement to save for a deposit. It can also help you avoid paying Lenders' Mortgage Insurance (LMI).
Like any financial decision, you need to weigh up the pros and cons - based on your personal financial circumstances.
If you decide to use the equity in your home to finance your next property purchase, be aware of the following:
This is why it’s so important to do your research and budget very carefully. You need to know what you’re in for, especially if interest rates rise or if your circumstances change. We recommend speaking to a broker who will be able to walk you through multiple scenarios to work out what you can afford and whether using available equity is the right option for you.
There are a number of ways of increasing the equity in your home, including: