What is home equity and how is it calculated?

Your home equity is the difference between how much your home is worth in the current market and how much you owe on your mortgage. In other words, your home equity represents the portion of your property that you own.

In this guide, we’ll look at what home equity is, how it’s calculated and how you can use it.

Home equity is the market value of your property minus any outstanding debts you owe on it, such as your home loan. You can calculate your home equity using this equation:

Market value (asset) - outstanding loan value (debt) = home equity ($)

Home equity can be expressed as a percentage (“I have 20% home equity”) or a dollar value (“I have $100,000 in home equity”). Either way, both describe your portion of homeownership.

Your home equity typically increases over time as you pay off your home loan, or the value of your property goes up.

It’s also possible to have negative equity – this is when the debt you owe to your lender is higher than what your home is currently worth in the property market.

Example of home equity

Let’s say your property is valued at $800,000 and you currently owe $500,000 on your home loan. In this scenario, your home equity is $300,000.

As shown in the example above, you can calculate your home equity using two details: the value of your property and the value of any loans against it.

But how do you calculate your property’s value? One way is to get a professional property valuation, which will take into account the size of the house, the condition of the property, the number of rooms it has and other factors.

Keep in mind that a property valuation can be legally binding and the value will be determined based on factual information. As a result, property valuations tend to be conservative.

Once you know your property’s value, you’ll need to total all your debts against the home next. This includes how much is still owed on your home loan and any personal loan debt you may have, such as from renovations.

Altogether, the value of your home minus any outstanding loan values can tell you how much home equity you have accumulated.

Home equity is an asset and therefore a form of wealth, and depending on how much you’ve accumulated, it can be used as security that allows you to borrow extra funds. We have an in-depth guide on how to use home equity, though you can read a brief rundown here.

Because having home equity can allow you to borrow additional funds, it’s a useful tool for people buying an investment property, as your equity can be used instead of saving up a cash deposit.

Your home equity can also be used to fund home renovations or allow you to be a guarantor on someone else’s home loan.

It’s unlikely that you’ll be able to access all of your home equity to use as security for these types of financial decisions. Instead, your lender can let you borrow what’s known as your usable equity or accessible equity.

Usable equity is typically 80% of your home’s value minus how much you still owe to the lender.

If you want to use your home equity to buy an investment property or otherwise get access to cash, you’ve got two main options:

Use your equity to refinance your current home loan

You can refinance your current home loan and increase it to a higher amount. You’ll then get access to the additional funds through your refinanced loan account.

Use your equity to apply for a home equity loan

Apply for a new loan known as a home equity loan and get access to the additional funds.

A home equity loan is a loan that lets you borrow from your home equity. You may also see it referred to as a second mortgage loan.

A home equity loan uses your property’s value as security, but different lenders will have different criteria for how much they feel comfortable letting you borrow.

There are generally two types of home equity loans:

Lump sum

Your lender will give you a lump sum from your home equity, to be repaid over an agreed amount of time. A lump sum is more useful for large purchases such as an investment property.

Line of credit

A line of credit acts more like a credit card. You’ll have access to a certain amount of money that you can use as you need it, and interest is paid on the loan’s balance.

You should weigh up the advantages and disadvantages of using your home equity before taking out any additional loans – here are some of the aspects to consider:

Pros of using home equity

Get access to additional funds

Your home equity acts as security for you to borrow money, which gets you access to additional funds you can use to buy an investment property, renovate your current home or fund other purchases you want to make.

Having home equity can be particularly advantageous when looking to buy an investment property, because you can purchase without having to save up cash for a deposit – but that doesn’t mean it’s without risk.

Competitive interest rates

The interest rates on home equity loans can be lower than the interest rates on standard personal loans and credit cards. Again, this is because your home equity in your existing property acts as security.

Flexibility

It’s possible to use the funds from your home equity for a multitude of investments.

Cons of using home equity

Increasing your debt

Borrowing using your home equity means you will be increasing your debt. This means your monthly mortgage repayments will increase, and it could take you longer to pay off your home loan.

Paying fees

You may have to pay lender costs and fees on the home equity loan.

Risk involved with investing

If you’re using the equity funds for renovations, there is a risk that you could overcapitalise by investing more money in renovations than the value it adds.

If you’re using the funds to invest in property, there is also a risk that you end up paying more than what the property is worth.

If you default on the home loan for your investment property, you could lose your primary home because it is acting as security on the property.

Home equity increases as you pay off your home loan or if the value of your home goes up.

There are a few key ways to increase your home equity:

• Make extra home loan repayments to pay off your mortgage faster.
• Avoid redrawing from your mortgage.
• Consider renovating to increase the value of your home.

If you’re just starting to pay off your mortgage, your home loan deposit is the main factor that determines your home equity.

This is because the size of your home loan deposit establishes how much money you need to borrow. The larger the deposit, the less money you’ll need to borrow from your lender. As a result, if you pay a 20% deposit, you have 20% equity in the property from the get go. 

In addition, having a larger deposit not only increases your equity but can also make you eligible for lower home loan interest rates, since lenders see you as a less risky investment.