How should I use my equity?
With Australian property prices on the up, up and up, homeowners have likely earned equity on their existing mortgages since purchasing. 'What is equity?', I hear you ask. One step ahead of you - there is already a blog on this very topic (read it here). In short, equity = assets - liability. If your house is worth $500k, and you have $200k remaining on your home loan, you have $300k worth of equity. Money in the bank, as they say!
Complacency, fear, or a lack of financial understanding are just some of the reasons homeowners don't unlock their equity. Of course, some may prefer to just pay their home loan off as quickly as possible, and save worrying about their next financial venture until the first is sorted. However, accessing your equity early can be a great way to build your investment portfolio, or increase cash flow - so for those reasons, it is definitely worth considering.
What are my options?
The world (or the property market) is your oyster! There are a number of different ways you can capitalise on equity.
Before you start making extravagant plans, you need to determine exactly how much equity you have to play with. Ask your local broker for a free property report to determine the current value of your house. Subtract your remaining home loan balance from this figure - and there's your total equity. You may decide to take advantage of one of the following methods:
- Use equity to obtain a second home loan
Once you've built up your equity, you can use this as security for your next property. Rather than requesting a cash deposit, the lender would determine how much useable equity you have (taking into account things like dependants, expenses, debts, income etc.) and would generally allow you to borrow up to 80% of your next property's value, while cashing in your equity to fund the remaining 20%. Find a house in an area experiencing rapid capital growth, and you'll be unlocking more equity to extend your investment portfolio in no time.
- Top up your home loan
If you need some extra cash for a one off payment (such as renovations, a new car, or a tropical holiday), then topping up your home loan may be your best bet. A top up works in a similar fashion to a personal loan, however you will likely benefit from a significantly lower interest rate. Be careful; just because you have plenty of equity to use, doesn't mean you should use it all and find yourself with minimal cash flow and no redraw to fall back on! Only top up what you truly need.
- Obtain a line of credit
Fancy the thought of a giant credit card? That's essentially what a line of credit is (though probably with a much lower interest rate!). A line of credit is a loan that lets you draw down amounts via card transactions and transfers, and pay these amounts back with interest. This line of credit would be secured by your home loan equity, and is a great method for increasing cash flow and making miscellaneous purchases for which the bank won't otherwise grant a loan. There are many advantages to this product, however always remember there is no such thing as free money - all borrowings need to be paid back eventually (+ dividends) so be careful not to indulge in slaphappy spending and land yourself in a financial pickle.
Disclaimer: The information provided in this article is not legal or financial advice. It has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider the appropriateness of the recommendations, having regard to your own objectives, financial situation and needs. We encourage you to consult a finance professional before acting on any suggestions provided in this article or on this website.
