How to use home equity: Buy an investment property, refinance your home loan and more

As you pay off your mortgage and build up your home equity, you can use it to refinance your home loan, purchase an investment property or even borrow funds for a home renovation.

This is because your home equity is the portion of your property that you own outright, and it can increase as you make repayments on your home loan or as the value of your property goes up. That makes it a valuable asset you can use as security to borrow additional funds.

Home equity is a form of wealth, so it can be a useful tool to help fund financial decisions. Homeowners and mortgage holders can use their home equity in a few ways, including:

• Buying an investment property
  
• Renovating your current home
• Refinancing to a lower home loan interest rate
• Investing in shares and managed funds
• Purchasing a car or paying for travel
• Going guarantor on someone else’s home loan.

If you’ve built up enough equity in your home, you can use it to purchase an investment property. This is a common strategy among investors looking to build their property portfolio.

You can use your home equity as a replacement for a cash deposit when buying property, meaning your current home is used as collateral for the new debt you’re taking on.

It’s worth noting that lenders usually won’t let you use all of your home equity to do this. Typically, it will only release around 80% of your home’s value minus the amount you owe to the lender. This is called your usable equity or accessible equity.

Usable equity is the portion of your home equity that your lender will allow you to use for the purpose of additional borrowing.

Let’s say you owe $300,000 on a property that currently has a market value of $600,000. To find out how much usable equity you have access to, you’ll first need to calculate 80% of your current property’s value.

$600,000 x 80% = $480,000

Next you’ll need to take that value and subtract the amount still owed on your mortgage.

$480,000 - $300,000 = $180,000

That means you can unlock $180,000 of home equity to use for a deposit on an investment property.

To calculate how much you can borrow, multiply the usable equity by four. The Rule of Four is a common yardstick for determining the maximum amount you should spend on an investment property, used by property investors and big banks such as Westpac .

$180,000 x 4 = $720,000

In this example, you’ll be able to borrow $720,000 using $180,000 worth of home equity for a 20% deposit.

Keep in mind you’ll have to budget for other costs associated with purchasing a home, such as valuation fees, settlement fees and stamp duty.

There are two main options for accessing your home equity. You can either use your equity to refinance your current home loan or apply for a home equity loan.

Both methods allow you to borrow additional cash using your home equity as security on the loan. Let’s look at both options in a little more detail.

Refinance your home loan

You can access your home equity by refinancing your current home loan and taking out a higher loan amount. This will give you access to the funds through a newly refinanced loan account.

You will be taking on more debt by doing this, and your monthly home loan repayments will go up.

Depending on the terms of your refinanced home loan, it could also take you longer to pay off – this means you’ll ultimately pay more in interest over time.

Other factors to consider are the interest rate you’ll need to pay on the refinanced home loan, and the cost to refinance a home loan.

Apply for a home equity loan

Your other option is to use your home equity to take out a home equity loan. This is an entirely new loan, and you may sometimes see it referred to as a second mortgage.

You can receive the funds from a home equity loan either as a lump sum or as a line of credit.

• Lump sum: You receive a lump sum of cash which needs to be paid back over an agreed time period.
• Line of credit: You gain access to a pre-approved amount of money that you can use as you need it, similar to a credit card.

Here we’ve outlined some of the basic steps you’ll need to take in order to use your home equity.

1. Calculate your equity: You can work out how much home equity you have by taking the market value of your property and subtracting any debts you owe against it.
2. Calculate your usable equity: Once you know how much equity you have in total, you need to calculate your usable equity, which is how much you can actually use. You should also consider how using your home equity will increase the cost of your mortgage repayments. Ensure that you’ll be able to service the additional debt you’re taking on based on your current income and living expenses.
3. Start comparing home loans: Now is the time to compare home loans, and consider your options for refinancing or applying for a home equity loan. It’s also a good time to reassess your current mortgage and see how it compares to others on the market. Compare interest rates, fees and features that could save you money.
4. Consider the costs of using your home equity: There can be fees and other charges associated with accessing your home equity. For example, if you’re using your equity to buy an investment property, you’ll need to factor in how much it will cost to refinance your home loan. Or, if your usable equity equates to a deposit of less than 20%, you may need to pay lenders mortgage insurance (LMI).
5. Submit your home loan application: Using your equity will require you to submit a new home loan application, whether you’re staying with your current lender or switching to a new one. This will involve standard home loan application paperwork, and once your application is approved, you can proceed to settlement.

If you want to go guarantor on someone else’s home loan, you can also use your home equity as collateral. This can be a way for parents who’ve been homeowners for a while to help their children get on the property ladder.

Refinancing is when you switch from one home loan to another, and when we talk about using home equity to refinance, there are two possible purposes.

Firstly, you can refinance your home loan in order to take out a higher loan amount and use the borrowed funds for an investment. 

The other reason to use your equity to refinance is simply to secure a better home loan interest rate, as the more equity you have in your home, the better bargaining position you’re in to get a lower interest rate.

This is because many lenders value ‘safer’ borrowers with higher built-up equity, and therefore a lower loan-to-value ratio (LVR), as they pose less of a financial risk than high LVR borrowers.

The idea is that the more of your home you own, the more security you have built up for the loan. You’re less likely to get into financial trouble, such as mortgage stress or mortgage prison, because you’ve handled the mortgage well so far and owe your lender less.

As a result, if you’ve managed to increase your home equity and decrease your loan-to-value ratio below 80%, 70% or 60%, you might be able to compare low rate home loans and make the switch to more affordable mortgage repayments.

Keen to lock in a better interest rate? You can compare refinance home loans now.