| Home Equity Explained
If you have been paying off your mortgage for a few years, you will most likely have built up some equity. Equity is the difference between the current value of your home and how much you owe on it. Your equity is probably your greatest asset.
Refinancing is a common strategy to be able to access the valuable equity in home to be able to fund renovations, an investment property or achieve other goals.
Calculating Your Home Equity
- You purchased a house a while ago for $500,000,
- Your deposit was $100,000 (20%)
- Meaning your loan was for $400,000
- Your equity in the home was $100,000
- Your home is now worth $600,000
- You have paid off $50,000 (from the principal)
- So – You now owe $350,000
- Meaning your equity is now $250,000
As a percentage:
You can do this by:
- Subtracting the loan value from the home value
- Then divide the result by the home value.
The equation (using above figures) looks like this:
- $350,000 Loan value ÷ $600,000 Home value
- = $250,000 Equity
- ÷ $600,000 Home value
- = 0.42 (Your equity is 42%)
Accessing Equity by Refinancing
In the above example – You have $250,000 (42%) equity in your property. To avoid lenders mortgage insurance (LMI) you can only lend up to 80% of the value.
- $600,000 Home value
- $480,000 80% of home value (maximum loan amount)
- $350,000 is the current amount of your loan
- So – $480,000 – $350,000
- = $130,000 (The amount of equity you can access without incurring LMI costs)
Building Your Equity
Obviously it is beneficial to build up your home equity. Building equity is one of the primary financial benefits of homeownership. There are a few ways to build increased equity in your home:
- Making loan payments – By only paying interest on your mortgage, you are not increasing the equity in your home, You need to be paying both your interest and principal. Over time this progressively increases the amount you are contributing to the principal.
- Paying larger or faster loan payments – It goes without saying that the more you can pay off your mortgage the sooner you reduce your principal. Also another method that has a compounding effect is paying weekly or fortnightly instead of monthly. This is an easy and achievable way of reducing your principal at a fater rate.
- Home value appreciation – Your equity will also grow in proportion to the amount your home appreciates in value. Most property appreciates in value over time (although it goes through cycles). So if your home appreciated by $30,000 in the last year, your equity also has grown by $30,000.
- Home improvements & renovations – This is a very good way to accelerate your equity stake substantially. For instance if you spent $30,000 on a new kitchen, this will normally increase the value of your home by more than the $30,000 that you spent. (You may find by spending $30,000 “wisely” your home may increase in value by say $45,000 +).
Buying an investment property with home equity
Buying an investment property using your existing home equity is a very popular investment strategy. The equity you have in your home can be used instead of a cash deposit to buy an investment property.
Different lenders will have different rules on this. So it is important to talk to a good mortgage broker for advice.