What does home equity mean and how does it work?

What does home equity mean?

Put simply, home equity is the difference between your property’s market value (what it’s worth) and what you currently owe on your home loan. So for example, if your home is currently worth $450,000 and your home loan balance is $350,000, then you have $100,000 of equity in your home.

Your equity increases as you pay off your home loan and as the value of your home increases. For example, if your property’s value increases from $450,000 to $500,000, it means you have $150,000 of equity in your home.

However, this also means that if the value of your home ever drops, your home equity will also suffer. So, if the market isn’t doing so well and the $450,000 home you own (with $100,000 of equity) is now only worth $400,000, you now only have $50,000 of equity in your home.

How do you determine how much equity you have in your home?

To find out how much equity you have in your home, you’ll need to have your property officially valued. If you’re just curious and a rough estimate will do, you can get an approximate value for your property by looking at other comparable homes on the market to see what they are selling for. You can also keep regularly updated on the current market value of your property by registering with an online listings website.

What can home equity be used for?

There are quite a few things that you can use your home equity for including:

• A deposit for an investment property: Using your equity as a deposit can help you get an investment property without having to spend time saving while also paying your home loan repayments.

• Financing a renovation on your current property: Using your current equity to pay for a renovation is a great way to improve your home without using your savings - and further increase your equity.

• Making a large purchase such as a car: Car loans can come with high interest rates and saving the money to purchase a car takes time. Using the equity in your home frees up money for your purchase now and gives you the benefit of a lower interest rate.

• Consolidating the other debt you have: Personal loans, car loans, and credit cards all have high interest rates and fees associated with them. Because of this, having multiple credit lines means you could be paying more interest and fees than you really need to. Using your home equity to pay out these debts bringing it all under the one loan means you are only paying interest (and fees if there are any) on one line of credit at a lower interest rate. 

How do I access my equity?

To access the equity in your home you'll do what’s known as a cash-out refinance. To do this you’ll need to increase your loan amount to account for the equity you want to use. Typically your lender will want to make sure you’re only borrowing 80% (in some cases 90%) of your property’s value so you’ll need to take this into account when deciding how much equity you want to use.

For example, if your property has increased in value to $500,000, you’ll have $150,000 of equity in your home. If you wanted to use some of that equity you could refinance your home loan (currently $350,000) for $400,000 (80% of $500,000), giving you an extra $50,000 in your pocket.

Please note, Qantas Money Home Loans does not offer this kind of refinance option at the present time.

How can you build your equity?

Aside from the market value of your home increasing, there are a few things you can do to help build up more equity in your home.

Make principal and interest repayments: When applying for a home loan you can choose between interest only (IO) or principal and interest (P&I) repayments. Interest only repayments mean you are only paying the interest amount that you’ve accrued each month, and your principal loan amount remains the same. This means you aren’t increasing your equity at all. P&I repayments mean you are paying both the interest that has accrued AND some of the principal amount of your loan. Which means as you make more repayments you are increasing your equity.

Pay more than your minimum repayments: Making additional repayments to your home loan will lower your loan amount quicker and increase your equity. Keep in mind though, that some home loans (fixed rate loans in particular) have a limit on how much extra you can put into your home loan each year.

Do a cash-in refinance: This is when you refinance your loan for less than your current loan amount, and contribute a lump sum of money to close your old loan. Refinancing does have some cost to it though, so you need to account for this as well.

Renovate to add value to your home: If you have the cash for it, renovating is a great way to add value to your home and increase your equity. 

Is it worth taking equity out of your house?

While using your home equity instead of dipping into your savings or taking out another loan may seem like a good idea, there are some downsides that you should be mindful of.

Firstly, when you liquidate your equity, you are increasing the amount of debt that you have (unless of course you’re doing so to consolidate your debt). You should make sure that you’re comfortable and able to handle this increased debt.

Secondly, as mentioned, there are some government costs and fees as well as lenders fees that you may have to pay. These can quickly add up and you may find that you don’t end up with as much extra money as you thought you would.

With any big financial decision it’s best to seek financial advice so you can be sure you get the outcome that’s right for you.

* You have to be a Qantas Frequent Flyer member to apply with Qantas Money Home Loans. This information has been prepared without considering your objectives, financial situation or needs. You should consider your circumstances before acting on this information.