Home equity plays a vital role in building wealth through property ownership, yet many buyers often find this concept puzzling.
As a buyer’s agent, I’ve noticed that while many people have heard about equity, they’re not quite sure how it works or how to use it to their advantage.
Today, I’ll break down everything you need to know about equity in simple terms, using real examples to show you how it can work for your property goals.
What Is Home Equity?
Let’s start with the basics.
The simplest way to explain equity is that it’s the difference between your property’s market value and what you still owe on your home loan.
Here’s a straightforward example:
If your property is worth $1 million and you owe $600,000 to the lender, your equity is $400,000. Think of it as the portion of your property that you truly own.
Breakdown of property value: This chart illustrates how a $1 million property is divided into a $600,000 loan and $400,000 equity.
How Much Equity Can You Actually Use?
Here’s where things get interesting.
While you might have $400,000 in equity, you can’t actually access all of it—and this is something many property owners don’t realise.
Most lenders will let you borrow up to 80% of your property’s value. Using our million-dollar property example:
- 80% of $1 million = $800,000
- Your current loan: $600,000
- Available equity: $200,000
So even though you have $400,000 in equity, you can only tap into about $200,000. This is what we call ‘available equity’, and it’s the amount you can potentially use for other investments or property improvements.
Note: Some lenders may lend you more than 80% of the property value, but this will likely incur additional charges such as LMI (Lenders Mortgage Insurance) and potentially higher interest rates or fees.
Smart Ways to Use Your Equity
Your available equity opens up several possibilities. Let’s explore each option:
Buy an Investment Property
Let’s look at how you can use your equity to purchase an $800,000 investment property.
The bank typically lends 80% of the property’s value, which in this case is $640,000.
You’ll need to cover the remaining 20% deposit—$160,000—plus purchase costs like stamp duty (around $31,000 in NSW) and other expenses such as conveyancing and building inspections, which may total $34,000–$36,000.
If you have $200,000 in available equity, you can use $160,000 for the deposit and the remaining $40,000 to cover these additional costs.
This allows you to purchase the property without using cash savings, but it also means you’re borrowing 100% of the funds needed for the purchase.
While this is a powerful way to leverage your equity, it’s important to note that most properties won’t generate enough rental income to cover all expenses, including loan repayments. As a result, you may face negative cash flow initially.
Renovate Your Current Property
Using equity for renovations can be smart, but there’s a golden rule:
Don’t overcapitalise.
Spending $50,000 on renovations should add more than $50,000 to your property’s value. Ideally, you’d want an increase of $80,000 to $100,000.
Other Options
While these aren’t typically recommended, you can use equity for:
- Starting a business
- Investing in shares
- Buying a car
- Taking a holiday
Remember, though, using equity for non-asset purchases means paying interest on expenses, which isn’t ideal for long-term financial growth.
Building More Equity in Your Property
Want to build your equity faster?
Here are a few effective strategies I share with my buyers:
Make Extra Loan Repayments
You’ll quickly reduce your loan balance by paying more than your minimum repayments or making them more frequently. As a result, less interest is charged, and more equity is built up over time. The beauty of this approach is that every extra dollar you pay reduces your loan principal directly.
Set Up an Offset Account
This is one of the smartest ways to manage your loan and build equity. Your offset account works by reducing the interest calculated on your loan.
For example, if you have $50,000 in your offset account against a $600,000 loan, you’ll only pay interest on $550,000. Your money is still accessible while you’re paying down the principal faster.
Add Value Through Smart Improvements
Strategic renovations can boost your property’s value, but let’s be clear about overcapitalisation. Here’s what I mean:
- Good scenario: Spend $50,000 on renovations that add $80,000-$100,000 in value
- Poor scenario: Spend $50,000 on renovations that only add $30,000 in value
Make Lump Sum Payments
Consider putting it towards your loan if you receive a work bonus, inheritance or other windfall. This immediately increases your equity position and reduces your interest payments.
Important Considerations
Before you tap into your home’s equity, here are some important points to understand:
Serviceability Requirements
Lenders will carefully assess whether you can manage the increased loan repayments by looking at:
- Your current income
- Your age
- Existing debts
- For investment properties, they’ll factor in about 80% of the potential rental income to allow for vacancies and expenses
Portfolio Impact
Let’s look at how using equity affects your overall position. Using our earlier example:
- Starting position: $1 million home with $600,000 loan ($400,000 equity)
- After investment: Combined property value of $1.8 million with $1.44 million in loans ($360,000 total equity)
This means higher leverage and gearing, which might suit some buyers but not others, depending on their financial situation and goals.
Cash Flow Considerations
When you borrow 100% of an investment property purchase using equity:
- Your loan repayments will be higher than with a standard 20% deposit
- This usually results in negative cash flow initially
- You need to ensure you can manage these additional expenses comfortably
Taking the Next Step
Understanding and using equity can open up opportunities to grow your property portfolio or improve your current home. But like any financial decision, getting the right advice for your situation is important.
The first step is understanding your current equity position. A mortgage broker or lender can help by:
- Arranging a property valuation to determine the current market value
- Assessing your borrowing capacity
- Calculating how much equity you can access
- Determining what loan structure might work best for your goals
If you’re considering accessing your equity to invest in property on the Central Coast, I can help you understand your options.
Our local market offers unique opportunities for buyers looking to expand their portfolio or make a sea change, and knowing how to leverage your equity effectively could be the key to making that move.
Equity can be a powerful tool for building wealth through property when used wisely. However, it’s crucial to approach it with a clear strategy that considers:
- Your long-term property goals
- Your risk tolerance
- Your current financial position
- The local market conditions
- Your capacity to manage additional debt
Want to learn more about how you can make your equity work for you?
Get in touch with me for a chat about your property goals. We’ll look at your current position and explore the possibilities that make sense for your situation.
