How to use home equity: refinancing your home loan, investing, and more

If you’re a homeowner, your home equity is worth knowing because it could affect everything from the home loan interest rate you pay to your ability to refinance your loan, or even purchase another property.

Intrigued? Let’s get into it.

When you take out a mortgage, your lender maintains an interest in your home until your debt is completely paid off. Home equity reflects the portion you own outright — that is, the difference between what your home is worth and the outstanding balance on your mortgage.

Home equity ($$) = Home value - loan value

As you pay off your loan though, the amount of equity you have will increase. The same will happen if your property’s value increases. However, if the home value goes down, so does your equity. 

To determine how much home equity you have, you’ll first have to find out how much your property is worth. You can do this by hiring an assessor to conduct a formal property valuation, using an online tool, or estimating using comparable sales in your area.

A few years ago Ella purchased an investment property which she recently had valued at $650,000.

Over the years she’s also managed to pay down a fair bit of her mortgage. Now the loan amount left on her mortgage is $275,000. 

Home equity ($$) = Home value - loan value

Home equity = $650,000 - $275,000

As a result, Ella has built up $375,000 worth of home equity.

Home equity is a form of household wealth, so it can a useful tool for financial decisions. Homeowners can use their home equity in a few ways, including: 

• Purchasing another property.
• Refinancing to a better home loan interest rate.
• Renovating your current home.
• Investing in shares and managed funds.
• Purchasing a car or travelling.
• Becoming a guarantor on someone else's home loan.

You may be able to leverage the equity in your home to refinance to a better home loan. This is because many lenders value ‘safer’ borrowers with higher built-up equity (and therefore a lower loan-to-value ratio) as they pose less of a financial risk than high LVR borrowers. 

The idea is the more of your home you own, the more security you have built up for the loan. You're less likely to get into financial trouble, like mortgage stress or mortgage prison, because you've handled the mortgage well so far and owe your lender less.

As a result, if you’ve managed to increase your home equity and lower your LVR below 80%, 70% or 60%, you might be able to switch to low interest rate home loan and take advantage of more affordable mortgage repayments.

If you’ve built up enough equity in your home, you might be able to use it to purchase a new property, or refinance so you can invest in another property. This is a common strategy among investors looking to build their portfolio.

That said, lenders usually won't let you use all your home equity to do this. Typically, they will only release around 80% of your home’s value minus the amount you owe to the bank. This is called your 'accessible equity'. 

Accessible home equity example

Let’s say you owe $300,000 on a property that’s currently valued at $600,000. To find out how much home equity you have access to, you’ll first need to calculate 80% of your current property’s value.

$600,000 x 80% = $480,000

Next you’ll need to take that value and subtract the amount still owed on your mortgage.

$480,000 - $300,000 = $180,000

That means you can unlock $180,000 of home equity to use for a deposit.

To calculate how much you could borrow, multiply the usable equity by four. In this example, you’ll be able to borrow $720,000 using $180,000 worth of equity for the 20% deposit.

Just keep in mind you’ll also have to budget for other costs associated with purchasing a home, such as valuation fees, settlement fees, and stamp duty.

Your home equity can change over time due to capital gains and losses, too. If you find yourself in negative equity, that means the amount you owe on your mortgage currently exceeds your property’s market value.

Usually property prices rise over time, and if you make both principal and interest repayments, then your home equity is usually safe. Bad luck can strike, however.

For example, if you buy at the top of the property cycle with a small deposit (< 20%) and the market undergoes a downturn, you could temporarily slide into negative equity.

Negative equity is mainly a problem if you intend to sell. Selling a home with a mortgage involves paying off the remaining balance, and if the property value isn’t enough to cover the loan amount, you’ll have to make up the difference.

Depending on your circumstances, that might mean drawing from your savings or even selling other assets. Your lender might also decide to actively monitor your finances to make sure you’re not shirking your loan obligations.

If the final payout falls short and you can’t come up with the necessary funds to cover your debt, your lender will turn the issue over to their mortgage insurer. After paying out the shortfall to your lender, they will then commence the process of recovering the amount you owe.

There are some ways to improve your home equity if you want to avoid this. This can include:

• Renovating your home to increase its value.
• Making extra repayments on your principal.
• Waiting for the property market to improve again.

With any luck, the speed and heat of the Australian property market will improve your equity in no time.

Keen to switch to a better home loan interest rate? Compare refinance home loans on offer below.