What is a home equity loan?
A home equity loan allows you to borrow money by tapping into the equity you’ve built in your home. You can access this equity in two main ways: by refinancing your existing home loan to increase its balance or by taking out a separate loan or line of credit.
Lump-sum home equity loans work just like a standard home loan agreement, where you borrow an approved amount and make regular repayments – including interest – over the loan term.
Home equity loans usually have terms of up to 10 or 15 years, or no fixed term if it’s a line of credit equity loan. Depending on the lender, you can normally choose between making principal and interest or interest-only repayments.
People borrow against their equity through a home equity loan for a variety of reasons, including home renovations and buying an investment property.
What is home equity?
Equity is the difference between your home’s current market value and the amount you still owe on your mortgage. For example, if you have a property with a market value of $800,000 and a mortgage with $500,000 left to pay, you would have $300,000 in total equity.
However, keep in mind you won’t be able to access 100% of your equity. Lenders generally like borrowers to keep some equity in your home to protect against the risk of owing more than the property's value if its value decreases. This is known as being in negative equity.
Lenders generally only allow you to access up to 80% of your property's value, minus your outstanding debt in equity. This is called usable equity — the equity in your home you can borrow against.
How to calculate the usable equity in your home
You can calculate your total home equity by simply subtracting your loan balance from your property’s market value. But, there’s an additional step to determine your usable equity. For instance, if your home is valued at $800,000 and you have $500,000 remaining on your mortgage, here's how you’d calculate it:
- Take 80% of your $800,000 property ($640,000)
- Subtract your outstanding debt ($500,000)
- Your usable equity is $140,000
Usable equity examples
Property value | $600,000 |
|---|---|
Outstanding loan balance | $400,000 |
Total home equity | $200,000 |
Usable home equity | $80,000 |
Property value | $800,000 |
Outstanding loan balance | $500,000 |
Total home equity | $300,000 |
Usable home equity | $140,000 |
Property value | $1,000,000 |
Outstanding loan balance | $600,000 |
Total home equity | $400,000 |
Usable home equity | $200,000 |
Property value | $1,200,000 |
Outstanding loan balance | $700,000 |
Total home equity | $500,000 |
Usable home equity | $260,000 |
Property value | $1,400,000 |
Outstanding loan balance | $800,000 |
Total home equity | $600,000 |
Usable home equity | $320,000 |
| Property value | Outstanding loan balance | Total home equity | Usable home equity |
|---|---|---|---|
$600,000 | $400,000 | $200,000 | $80,000 |
$800,000 | $500,000 | $300,000 | $140,000 |
$1,000,000 | $600,000 | $400,000 | $200,000 |
$1,200,000 | $700,000 | $500,000 | $260,000 |
$1,400,000 | $800,000 | $600,000 | $320,000 |
Home equity loan types and how they work
There are three main types of home equity loans:
1
Cash out refinance
You can borrow against the usable equity in your current property by refinancing your home loan. In this case, it means increasing your loan amount and getting the released equity paid to you in cash. You can then use the cash as a deposit for an investment property or your next home, or to fund renovations or other investments.
The cash used for the deposit will be secured by your current property. However, the new loan you take out for the rest of the purchase will be secured by the new property. Essentially, you're using your current property to help finance the deposit, but the majority of the new purchase will be financed with a separate loan, secured by the new property.
According to Westpac, most property investors choose to access their equity by refinancing an existing loan, which can make managing the increased debt easier than having a separate loan.
2
Home equity line of credit
A line of credit allows you to withdraw funds whenever you need up to an approved limit based on the usable equity in your home. You only pay interest on the funds you withdraw, not on the entire line of credit.
According to Westpac, many investors choose a home equity line of credit to pay for renovations or home improvements or to make personal investments.
3
Home equity loan
A home equity loan is a new loan separate from your existing mortgage. It’s paid out to you in a lump sum that you repay with interest in regular instalments over time. A home equity loan is secured by your property, with your cashed out equity used as a deposit.
Your home equity loan is a separate account from your initial home loan and can be set up to suit your financial goals. If you access your equity with a separate loan, you can choose a different loan term and features that suit your needs. This set up means you’ll have to service two loans instead of a larger loan through a simple refinance.
Not all lenders offer second loan options when refinancing. For example, ANZ and NAB only allow you to access equity by refinancing (topping up) your existing loan. It’s important to check with your lender to understand your options, or you can speak with a mortgage broker to find the best products for your needs.
How much can you borrow with a home equity loan?
You can typically borrow up to 80% of your existing property's value, using the equity as a deposit to buy a new home.
For example, if your home is worth $600,000, you could borrow up to $480,000 (80% of $600,000). However, the actual amount you can borrow depends on your existing mortgage balance. If you still owe $300,000, you could access up to $180,000 in equity through a home equity loan or line of credit (calculated by subtracting the $300,000 you owe from the $480,000 maximum borrowing limit).
According to Money.com.au’s home loans expert Mansour Soltani, some banks may lend you up to 90% of the property’s value, but this will likely incur lender’s mortgage insurance (LMI) and a higher interest rate.
What can a home equity loan be used for?
A home equity loan can be used for various purposes, including:
To buy an investment property or second home
Many investors use their home equity to help finance the deposit for an investment property. You can do this with a loan top-up, where you increase your current loan amount by refinancing, or by taking out a supplementary loan. Using home equity this way can help you leverage your property’s value to secure the funds needed to expand your investment portfolio or buy a second home.
To fund renovations or home improvements on your existing property
You can access your home equity to fund home improvement projects, which can help increase the value of your property. If you have a home renovation planned, such as a new bathroom or a bedroom to accommodate a new family member, you might be able to use the equity you have in your home to fund it and increase the value of your home at the same time.
To consolidate debt
If you have enough equity in your property, you may be able to borrow against it to consolidate your high-interest debt (e.g. credit card balances and personal loans) into a single loan amount at a lower interest rate. This can help streamline your repayment obligations.
To buy shares and other investment products
You may be able to unlock some of your equity to make personal investments in other assets like shares, bonds, mutual funds, ETFs or other financial products. It’s best to speak to a financial advisor about your investment goals and risk tolerance before using your home’s equity to invest.
Investors should consider a loan with an offset account
Mansour Soltani , Money.com.au's home loans expert
“Most investors choose an interest-only home equity loan to lower their repayments and increase their cash flow, but doing this generally adds 0.5% to your interest rate. Consider looking for a home equity loan with an offset account. You can generally claim expenses paid out of the offset as a tax deduction, something that is not possible with a redraw.”
Mansour Soltani , Money.com.au's home loans expert
What to look for in a home equity loan?
Interest rate
The interest rate plays a big part in determining how much you’ll pay over the loan term. Compare rates from different lenders and ensure you’re getting a competitive deal. For example, if one lender offers an interest rate of 7.80% and another offers 8.20%, over a 10-year term, that 0.40% difference could save you thousands of dollars.
Loan terms
How long you have to repay the loan will affect both your monthly repayments and the interest charged. Shorter terms mean higher repayments but less interest paid over time. For instance, a 15-year term will mean smaller repayments than a 10-year term, but you will end up paying more interest overall.
Loan-to-value ratio (LVR)
LVR is the percentage of your home’s value that you can borrow, and lenders vary in terms of the maximum you can borrow. The higher the LVR, the more you can borrow, but this could mean the loan comes with a higher interest rate and stricter lending criteria. If a lender allows you to borrow more than 80% of your property’s value, you may also likely need to pay lender’s mortgage insurance.
Will your financial situation affect your options?
Financial details like your credit score and income are generally less important in determining the rate on a home equity loan compared to personal or car loans. However, they can still influence which lenders’ rates you may be able to access. Typically, borrowers with more equity in their property have access to the widest range of the best rates and terms.
Flexibility of the loan
Some home equity loans offer flexible features like the ability to make extra repayments and a redraw facility. Extra repayments help you reduce your loan faster, saving on interest, while a redraw facility lets you access those repayments if needed later. These features provide flexibility, but be sure to check if there are any fees or restrictions.
Fees and charges
Always check for any upfront, ongoing or exit fees. Some lenders charge application fees (i.e. $200-$600), while others might have early repayment penalties. Make sure you check the fine print to understand all costs involved.
Home equity loan pros and cons
Pros
- Offers an avenue to purchase an investment property sooner without needing to use your own cash savings
- You can borrow a large sum of money, often up to 80-90% of your home’s value
- Flexible repayment terms and options available depending on the lender
Cons
- Your existing home is used as security, so you risk seizure of your property if you default on the loan
- Application and ongoing fees may apply, increasing the total cost of the loan
- Borrowing too much against your home’s equity can be risky, especially if property values decrease
How to build equity in your home
You can build equity in your home in two main ways: waiting for your property’s value to increase (hopefully), by making renovations to increase its value, or by paying down your mortgage.
- Capital growth: If the value of your property rises over time due to market trends, this increases your equity. For example, if you bought your home for $600,000 and its value increases to $700,000, your equity has grown by $100,000.
- Renovations: Making improvements to your home, such as updating the kitchen or adding a new bathroom, can boost its value and, in turn, your equity. Even small changes, like landscaping or upgrading your toilet, can have a noticeable impact on the home’s market value. It’s important to budget carefully for the work to make sure the money you spend is comfortably offset by the expected increase in your home’s value. Discussing your plans in advance with a property expert is a good idea.
- Paying down your mortgage: Making extra payments on top of your regular home loan repayments means you'll be chipping more away from the amount you owe and increasing your equity faster.
