Home Equity Help
What Is Equity
Home equity is the portion of your property that you truly own. It's the difference between your property's market value and the balance of your mortgage. Your equity increases over time when payments are made against the mortgage balance and/or if the property value increases.
In other words, it is calculated by subtracting the existing loan amount from the property's market value. Equity can be very helpful when it comes to purchasing your next investment property, it's definitely worth looking into.
How Does It Work?
Ok, so it may sound complicated, but it's not too difficult when you understand how it works. We'll break it down with an example; Let's say you already have a home and you are interested in investing in another property with a market value of $300,000. You also need to take into account that there are legal fees, stamp duty costs, etc. totalling $15,000. The market value of $300,000, plus $15,000 additional costs, amounts to $315,000.
A lender will usually fund 80% of the market value, as long as you meet the loan approval requirements. The bank may fund you more if you pay Lender's Mortgage Insurance (LMI). Ok, so let's break it down... the bank will lend you $240,000 to buy the investment property. Considering you have a total property cost of $315,000 you will still need an extra $75,000 for the deposit and additional upfront expenses. This can come from the equity in your existing home.
Now let's work out the total equity you have in your existing home. For example, let's say the market value of your existing property is $400,000 and you have a balance of $200,000 owing on your mortgage. If you deduct the balance from the market value, you will be left with a difference of $200,000, which is your total equity.
It is important to note that although you have a home equity of $200,000, not all of this is available equity. Typically the available equity in your home is calculated at 80% of your property's market value, this is the amount the bank will usually allow you to use. So let's work it out; in this case it's 80% of $400,000, which is $320,000 (without the need to take out LMI) minus any current loans, in this case the loan amount is $200,000. So $320,000 minus $200,000 equates to = $120,000 available equity.
Equation for Available Equity (without needing to take out LMI) is:
80 % of Property Market Value - Debt Owing= Available Equity
Sometimes lenders will allow you to borrow up to 95% of the property value minus the existing mortgage, where LMI would be paid on the amount borrowed over 80%.
KEY TAKEAWAY: Home equity loans grant access to a generous pool of money and they can be a valuable tool for wealth creation. If your property has gone up in value, then the amount of equity in your property will have increased too. Everything else aside, the most important thing is to play it safe. If you don't have any extra money apart from your home equity then you should assess the risk associated with using all of your equity without a buffer before taking any money out of your home. A good idea would be to contact a finance specialist to discuss your unique situation before making any final decisions.