Home equity is a financial asset tied to your home – and one that can be used to your advantage in a few exciting ways. Beyond investing in your future, the equity you build up in your home can become a pool of potential value.
In simple terms, home equity is the difference between your homes market value and what you still owe on it. As your pay down your mortgage over the years, the equity builds up. It’s a big part of home ownership – but something that’s often overlooked. Here’s what you need to know about the basics of home equity, as well as how you can use it to potentially grow your wealth and property portfolio.
What is equity in a property?
Equity is a measure of your property ownership as it represents the ‘portion’ that belongs to you. It’s the difference between the market value and the outstanding mortgage balance. As you pay down your mortgage or your home appreciates in value, your equity goes up. Moreover, useable equity (also referred to as accessible equity) is the amount you can leverage for various purposes.
What can equity be used for?
You already know that you can use equity in your current home to invest in another property. But what you might not realise is that it can actually be used for a number of other things.
One common application is improving your home – using equity to renovate or upgrade your property can make a big boost to its overall value. Equity can also be an effective resource for financing major life events, such as a dream holiday or buying a new car.
One big advantage is that the interest rates on home equity loans or lines of credit are often lower than other forms of credit, resulting in long-term cost savings. Whether you’re looking to consolidate high-interest debt, invest in your kids’ future education, or fund a large purchase, tapping into your property’s useable equity can be a cost-effective strategy.
How can home equity help?
Taking advantage of your home equity to buy a second property can be a strategic financial move with several benefits:
· It provides the means to expand your real estate portfolio, potentially growing your overall wealth and setting you up for a more comfortable retirement.
· Using home equity for a second property can offer a few tax advantages, as mortgage interest payments could be tax-deductable in some circumstances.
· By diversifying your investments, you are essentially ‘spreading out’ your level of financial risk across multiple assets.
· Using the equity in your existing property means you can access better terms compared to other forms of credit. In other words: lower interest rates.
How to calculate home equity
Calculating the equity of your home is straightforward and involves subtracting your outstanding mortgage balance from the current market value of your property. Because property values tend to fluctuate, keeping an eye on your home loan equity is necessary when you are preparing to use it.
Start by getting an up-to-date property valuation, either through a professional appraiser or by using online property-valuation tools. Once you have this figure you can use the following calculation:
Home value – outstanding mortgage = equity
For example, if your property is valued at $1,000,000 and your outstanding mortgage is $800,000, your equity is $200,000.
5 things to consider before using your equity
1. Interest rates: Do a bit of research into the interest rates that come with using your home equity and how they compare to other financial options.
2. Loan terms: Always read the terms and conditions of equity-based loans, including repayment schedule and potential penalties for missed payments.
3. Property value trends: What’s happening right now in the current property market? Consider the current and future trends of property values, as they might impact your decision to borrow additional funds.
4. Your financial situation: Assess your overall financial stability to make sure you are matching your home-equity plans with your long-term financial goals and risk appetite.
5. Impact on loan-to-value (LVR) ration: Find out how using your equity might affect your loan-to-value ratio. This can influence your eligibility for certain loans and lower interest rates.
To keep learning about home equity and how it can benefit you and your family, read part 2.
