How to use home equity to pay for big-ticket items

Home owners have access to a secret weapon that can make a big difference to their finances and therefore, life: equity.

“Equity can make a huge difference to a person’s life and financial outlook, as the more equity someone has, the more money they could potentially have access to,” says Jospeh Daoud, mortgage broker and CEO of It’s Simple Finance.

Equity is the difference between a home’s current value and any debt still to be paid on the loan. For example, if your property is worth $1 million and your mortgage is $700,000, you have $300,000 in equity. If your property value then increases to $1.1 million but you’ve also paid $100,000 off your loan, your equity is now $500,000.

Of course, this equity can be accessed by selling, but those who choose to retain their property are able to keep their investment and use the equity to fund big-ticket items, including a holiday or their next property.

Equity 101

“Using your equity is basically letting your LVR work for you,” says Daoud. LVR is your loan-to-value ratio, the amount you need to borrow from a lender.

“For example, if someone previously purchased a property, for $500,000 and their loan was for $400,000, their LVR is 80 percent. It’s much harder to tap into this equity as you have to find a lender that will allow you to borrow over 80 percent without incurring lenders mortgage insurance fees (LMI),” he explains.

Accessing the equity is basically asking for another loan and taking on more debt, so the lender will assess the risk like it did when you applied for your initial mortgage.

A higher LVR poses more risk to the lender, which is why LMI is usually instated when the LVR is 80 percent or more, or when you have less than 20 percent of the deposit.

“However, if the property has grown from $500,000 to $600,000 (which we’ve seen a lot of in the last year) and your loan has decreased from $400,000 to $350,000, you can then draw that up to 80 percent,” explains Daoud.

Eighty percent of $600,000 is $480 000. When you subtract the current loan size of $350,000, that leaves you with $130,000 of useable equity.

How much equity can a property owner access?

Your home may be worth a certain amount, but that doesn’t mean you lender will allow you to borrow the full amount of equity.

“The reason lenders may not allow access to full amounts of equity is because they may see you as:

1. Unable to make the additional repayments
2. Using the equity for something that the bank does not see fit,” says Daoud.

“For example, if you own a $500,000 property and it so happens to increase to $1.5 million, you may have been able to service the previous $400,000 loan, but you may not be able to service the additional amount that you’re looking to attain.”

Daoud also outlines that your reason for accessing equity plays a role, with banks looking unfavourably on overdue credit card debt, a tax debt or liability, or other things like luxury or designer items. Read: lender’s don’t love releasing funds without suitable justification.

Certain lenders may allow you to borrow up to 90 percent of your property’s value depending on your conditions and purpose, but with your debt increasing and therefore repayments set to rise, it’s recommended not to go over 70 percent.

The homeowner needs to first assess whether they’re able to make increased repayments before drawing on any equity.

What big-ticket items can equity be used for?

“You can tap into equity to purchase big-ticket items, such as another property or a vehicle or a boat,” explains Daoud.

“The way you do this is either via an equity release or refinancing, whichever is best suited to your situation.”

Items include:

1. Renovations (both structural and cosmetic – however, large-scale structural renovations will likely require a construction loan)
2. Purchase of future investments (be it shares or another property)
3. Purchase of a holiday home
4. Purchase of a vehicle or boat
5. Payment of a holiday or wedding
6. To pay off short-term debt such as: car loans, personal loans, credit cards (as long as there are no dishonours) and HECS debt

How to use equity to buy another property

Equity can be a savvy strategy to grow your property investment portfolio, as you’re essentially leveraging the growth in your first home to fund a deposit for the next home. As the value of the next property increases, you may be able to rinse and repeat the process.

“You can tap into equity to attain your 20 percent deposit and be able to purchase more property in the future,” says Daoud. This means you can make your next move without using your own personal cash savings.

“You can use the rental income to assist in paying off the mortgage, and if needed, you can use negative gearing to assist in offsetting tax. You can recycle this process the larger your portfolio becomes to be able to purchase more properties down the line.”

If this is something you’re looking to do, it’s imperative you engage a skilled and qualified broker with personal experience in investment properties.

“The role of your broker will be to ensure that you can continue to service these home loans while continuing to live your ideal lifestyle without breaking the bank,” adds Daoud.

It is also important to understand that this strategy relies on property value increasing, which is never guaranteed. Working with a financial professional will help you to understand and be comfortable with any risk involved.

The information provided on this website is general in nature only and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information on this website you should consider the appropriateness of the information having regard to your objectives, financial situation and needs.