How to use home equity: Refinance your home loan or buy an investment property

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

This is because your home equity is the portion of your property that you own outright, and it increases as you make repayments on your home loan, or the value of your property goes up. That makes it an asset you can use to your advantage.

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

• Buying an investment property
• Refinancing to a lower home loan interest rate
• Renovating your current home
• 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 might be able to use it to purchase a new home, or refinance so you can invest in another property. This is a common strategy among investors looking to build their property portfolio.

In this scenario, your home equity acts 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.

That said, lenders usually won’t let you use all 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.

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.

Refinancing is when you switch from one home loan to another, and the more equity you have in your home, the better bargaining position you’re in to refinance to a better home loan 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.