Right now, most Australians are reviewing their finances from their monthly gym membership to their home loans. And, while it’s important not to make any fear-based financial decisions, it is a good time to learn what your options are; like taking out a home equity loan.
So how can a home equity loan benefit you now or in the future?
We’ll explain what a home equity loan is, how to determine your loan-to-value ratio (LVR), how a home equity loan differs from a home equity line of credit (LOC) and what you can purchase with a home equity loan.
A home equity loan allows you to borrow against the equity in your property.
So, what is your home’s equity?
Most homeowners expect their property to increase in value as they pay off their home loan. As your home increases in value, you begin to accrue equity. Home equity is the difference between what you owe on your mortgage and what your home is worth.
For example, let’s say your home is valued by your lender at $750,000 in the current market and you owe $200,000 on your mortgage. Then, your home equity would be approximately $550,000. You may be able to borrow against this amount from a lender if your loan-to-value ratio (LVR) is less than 80%.
Your loan-to-value ratio (LVR) is one of the factors your lender considers when they decide if they’re going to approve your loan application. When your LVR is higher than 80% you may be required to pay for lender’s mortgage insurance (LMI).
In addition, the lower your (LVR), the less risk your loan carries. Your LVR is determined by adding the amount of your original home loan’s balance and your new loan. Then, you divide the total by the value of your home determined by your lender.
Using the example above, your property is valued at $750,000. You owe $200,000 on your home loan and you want to borrow an additional $150,000.
To calculate your LVR:
$200,000 + $150,000 = $350,000
Then, divide $350,000 by the value of your property $750,000
$350,000/$750,000 = .46 or an LVR of 46%
While both home equity loans and home equity lines of credit (LOCs) are based on your home’s equity, they are not the same. Your home equity loan gives you a lump sum of cash upfront that you repay over time with fixed monthly repayments, just like your home loan. Like all loans, you will pay interest on your home equity loan from the beginning.
With a LOC, you’ll receive a maximum amount available for you to borrow with often a variable interest rate.
You can use a home equity loan for most major purchases like:
Home renovations, which help increase the value and the equity of your home
Buying investment properties
Buying a business or investing in your business (subject to meeting a number of the banks credit conditions for business purchases)
Consolidating your debts like credit cards or personal loans into your home loan
Major lifestyle purchases like buying a new car, boat or caravan
Taking out a home equity loan can help you reach your next property or lifestyle goals. At Hargate Advisory, our experience working with complex deals and financial structures makes us well-placed to ensure you realise your dreams. We can recommend the lender that will offer you a good interest rate with affordable monthly payments and advise you on the best approach.
If you’re not ready to take on a home equity loan, but want to consider other options with your home loan, talk to us about refinancing. Refinancing can help you own your home sooner or get the best deal on your loan repayments.
Learn more about staying calm and refinancing with us: Refinancing