Use Equity to Your Advantage to Buy Property in Australia
Accessing equity in your property is a great strategy for those of you who are intending to purchase a new property, make additional investments or need to tap into savings for other purposes. You get to convert the equity you have built up in your property into cash, allowing you to diversify your investments or reach other financial goals.
Sounds pretty good hey?
But as with any other financial strategy, with great sounding deals come great responsibilities: when you choose to cash out equity, you are putting your property on the line. If the value of your property decreases, you could end up owing more than your property is worth. So before you rush into getting cashing out, take a closer look at what taking a home equity loan in Australia entails, when you may want to consider this financing option and whether it is a strategy that is best for you.
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What is home equity?
Home equity is the difference between the current market value of your property and the amount you owe the bank. The amount fluctuates overtime as the value is tied to market forces.
Equity in a house is initially acquired with the down payment you make during the initial purchase of the property. As you repay your mortgage, the outstanding loan balance will be reduced, hence increasing your level of home equity. Another way to build up equity is to increase the value of your property by maintaining and improving it. If your property happens to be in an ideal location, chances are your property is likely to achieve long-term capital growth.
How cashing out works
Australian home equity loans generally have lower interest rates than other forms of borrowing. We can’t say which is better – it depends on your financial goals and preferences.
Lenders assess your property’s current market value and the remaining mortgage balance to evaluate the loan amount. As the home equity loan is secured by the value of your property, the risk to the lenders is lowered.
Another product closely related to a home equity loan is a reverse mortgage. It is mainly reserved for retirees and allows them to tap into the savings they have accumulated in their property. With a reverse mortgage, no regular repayments are needed (it is entirely up to you!) and you have guaranteed lifetime occupancy – the outstanding balance will be due either when the property is sold or when the borrower passes away.
How much would I be able to borrow with a home equity loan?
Generally speaking, the amount you can borrow can be calculated with this formula:
(Property’s Value x 80%) – Mortgage Balance = Accessible Equity
For example, if your Property’s Value is worth $600,000 and the remaining balance on your mortgage is $250,000, then the Accessible Equity is $230,000.
Most lenders are happy to lend up to 80% of the property’s loan-to-value ratio (LVR), though policies differ between lenders. Some lenders can do higher than 80% LVR, however, as the risk for lenders increases, the lender would require the borrower to pay an extra fee (ie: lender’s mortgage insurance, or LMI) in case the borrower defaults.
Other lenders have strict cash out policies, reducing the amount of money you can borrow. They are cautious when lending money in the form of equity loan as some borrowers use their equity carelessly and provide quite little to no evidence of how they are spending the borrowed funds.
Reasons to use your home equity
There are not many limits on how you can use your home equity but there are few ways to make the most out of it:
A home equity loan can be used to consolidate high-interest debt into a single amount at a lower interest rate. Some borrowers use it to pay off their personal debt (which is also fine!) The downside is that you might turn unsecured debts, such as credit card debt, into a debt that is now backed by your home.
Home Renovation and Improvement
Besides making a home more comfortable for you, by doing so, you could raise the property’s value and draw more interest from prospective buyers when you rent it out or sell it later on. However, before using home equity for home improvements, do research to see if the improvement will produce a good return on investment to avoid overcapitalisation.
Investments come with risks (we all know that), because there is no guarantee that the stock market will perform well. The same goes with investing in real estate. You can’t be certain that the investment property won’t lose its value or fail to bring in the income needed to get a return on your investment over time. So before you proceed with investing, make sure that you look into all your options and see whether the investment is a wise one.
If you have an emergency and no other means to come up with the necessary cash, a home equity loan may be a smart way to stay afloat (only if you have a backup plan or if you are pretty certain that this financial situation is temporary). However, the application process time associated with accessing home equity may not be ideal for a time-sensitive emergency.
How to prove the purpose of your home equity loan
Many lenders require you to provide the purpose of the loan as part of the application process. Requirements vary among major lenders, some may ask you to provide an accountant’s letter and a copy of a statement of advice. These documents are necessary if you will spend the borrowed money to buy shares.
You will have to submit a letter from the conveyancer if you want to invest in a property. It will prove that you have found a property and you want to buy it. You can also use the loan for debt consolidation. It will require you to provide the latest statement to prove you are repaying all your debts on time.
Pros and Cons
The advantages of a getting home equity loan
- Lower interest rates compared to other types of personal loans or home loans
- Higher chance of approval compared to other kinds of home loans
- Higher flexibility as the funds can be used for any potential purpose
- Higher investment potential as borrowers can unlock the equity in their property to use for other investments
- Complete freedom to repay interest amount
The disadvantages of a getting home equity loan
- Increased outstanding debts hence increasing monthly repayments and repayment duration
- Increased fees (eg: transaction costs, lender fees)
- Risk of reduced credit score
- Risk of foreclosure
- Never resort to a home equity loan to fulfil your monthly needs. You won’t get anything valuable in return by investing in your living budget. You might end up consumed by debt.
- It is also not a good idea to take home equity loan Australia to fund entertainment and leisure. This would worsen the debt issue because you are risking your property for extravagant vacations, entertainment and leisure.
- Don’t borrow more than you need. Be financially disciplined and don’t put your house at risk of foreclosure for a frivolous purchase.
- There is a limit to how much you can borrow
The market is highly competitive and there is a vast range of products on offer from lenders, including home equity loans. Not sure whether releasing your home equity is the best thing for you? Not sure which lender to go with?
Contact us to find the best solution for your circumstances!