Equity in your property is the difference between the market value of your property and the amount you owe on your home loan. So if, for example, your property’s value is $675,000 and your loan amount is $500,000, the equity you have is $175,000.
There are two main ways to build your equity – increasing your property’s value, and/or paying off your home loan as fast as possible.
You can increase the value of your property by renovating or making small changes to make it more attractive to potential buyers and ultimately improve the market value of your property.
Additionally, making changes to your repayments can help pay down your loan sooner. Increasing the amount of your loan repayments by making extra repayments, or increasing the frequency of repayments, can have a significant impact in reducing the amount of money you owe, thereby building your equity.
For instance:
- You have a principal and interest home loan worth $500,000 paying 2.19% interest, so your current home loan repayment would be $1,896 per month.
- You’re three years into your loan, so you have 27 years remaining on your loan term. You increase this repayment to $2,000, meaning an extra repayment of $104 a month.
- By making this small additional payment each month, you’ll own your home outright in 25 years and two months. Your home loan reduces by one year and 10 months.
Another way to build equity is to consider an interest offset account. An offset account can be a transaction account linked to your home loan. The balance of the offset account is offset against the home loan debt, reducing the amount of interest owed and enabling you to pay off the loan faster.
Using your equity
Once you’ve built your equity up you may want to use it to renovate, make investments or purchase something else. Options to do this include repayment redraws, using line of credit or accessing the funds in your offset account.
It’s important to understand that you usually can’t access all of the equity in your property. Let’s go back to our earlier example:
- Property value = $675,000
- Loan value = $500,000
- Equity = $175,000
In this scenario, you have equity of $175,000. But you can generally only access or borrow up to 80% of the property’s value before extra costs like Lenders Mortgage Insurance (LMI) become payable. This means that in this example, the usable equity looks more like this:
- Property value = $675,000
- 80% of property value = $540,000
- Loan value = $500,000
- Usable equity = $40,000
How does equity work when buying a second home?
You may choose to use some of the equity in your home as a deposit on an investment property.
Many investors use the equity in their property as a deposit on an investment property, which they ‘buy and hold’. Accessing the equity means you’re paying interest on the full purchase price of the property, including both the deposit and the rest of the loan.
When looking to invest in property, having a clear idea of the financial goal(s) you’re hoping to achieve long-term can help you find the right investment property.
Remember that using your equity will increase the amount you owe overall, so make sure you think through both the benefits and risks of using this money.