'Equity' is an important concept in property - the equity you build could help you buy another property, lower your interest rate, or qualify for a larger loan. Here's what you need to know about how it all works.
What is equity in a home?
Equity basically means how much of your home you own outright. It's the portion of the value of your property that doesn't have an outstanding mortgage on it - if you have $200,000 remaining on your home loan and your property is worth $800,000, you have $600,000 worth of equity.
You can use our Equity Calculator to estimate how much equity you have in your home
How does equity work when buying a second property?
Equity in your home can make it easier to buy additional properties. Once you've built up enough usable equity, you might be able to use it as a deposit or security for a new home loan.
What is useable equity?
Lenders often distinguish between total equity and 'useable' equity. Generally borrowers are only allowed to access up to 80% of the total equity they've built up in their property, to minimise the risk of a borrower falling into what's known as negative equity, where the outstanding amount owed is worth more than the property.
If you're looking to borrow against your useable equity, some lenders might also reduce the amount available based on your income and expenses.
Using equity as a deposit
Many borrowers choose to withdraw the useable equity they've built up to buy additional properties, as a downpayment or sometimes even buy outright.
There are a few different ways to do this. You can refinance your existing loan - with the same lender or a different one - and borrow more against your equity. Say you have $200,000 worth of useable equity - you might be able to add another $200,000 to your existing loan and buy a second home with a $200,000 deposit.
You could also borrow against your equity using a line of credit loan. These are often more expensive than conventional home loans, but you're usually only charged interest on the amount you actually end up using.
Alternatively, if your current home loan has a redraw facility, you might have made enough additional payments over the years that you can take out a hefty lump sum. The money available in your redraw isn't your whole equity, just the amount you've paid beyond your mandated minimum repayments, but if you've paid a lot more than what you needed to, you might still have enough in your redraw for a deposit.
Using equity as security
Useable equity can also work as security for further borrowing through cross-collaterisation. This basically means using your existing property as well as the new one you're buying as security for another loan. This can significantly reduce your Loan to Value Ratio (LVR) which could mean lower interest rates. However, if you default on the loan you run the risk of having both properties repossessed. There can also be more restrictions on cross-collaterised loans - for example you might need to have both loans with the same lender.
How else can you use equity?
Your useable equity could also go towards:
Home renovations
A popular use of equity is to use what you've built up on improvements to your property.
Completing renovations can sometimes even help you build equity. For example, if you borrowed $10,000 from your equity to spend on a new kitchen, which increases the value of your property by $30,000, you've improved your equity by $20,000.
Investing in other assets
You could also use your home equity to invest it in other assets like shares or exchange-traded funds (ETFs). This way, all of your money isn't tied into one big asset, i.e. your home, and you have a more diversified investment portfolio. The portion of the loan that you put towards investment might also be tax deductible.
A note from Moneysmart: Using home equity to invest in other assets isn't recommended for new homeowners, as they'll need to use their home as collateral if they make a loss (which is a big no no). But it is something often done by more established property investors.
One-off expenses
Some borrowers get an equity release to spend on one-off expenses, like a wedding or a holiday. Since home loan rates are often significantly lower than personal loans, this is generally cheaper than getting a separate loan.
How to raise equity in your home
If you don't currently have enough equity in your home to do anything with, there are two ways your position can improve. You can either pay down more of the loan, reducing the amount you owe, or your equity can increase as your property appreciates in value.
Pay off more of your home loan
When you make additional repayments, you're not paying any interest - you're only paying off the principal amount. Of course, this reduces your overall loan balance, which reduces how much interest you're charged. Interest is only charged based on how much you have borrowed. So making extra repayments reduces your principal and interest, which could allow you to make even more extra repayments. Chipping away at your home loan's principal is what accumulates your equity.
Grow your property value
Once you buy a property, any amount that its value appreciates by improves your equity position. Say you buy a home for $800,000 with a $600,000 loan (an equity position of $200,000). Even if you pause your repayments, if the value of the property goes up to $900,000 your equity position has improved by $100,000 without you paying anything.
The value of your property depends on all sorts of factors, but renovations and other improvements are one way you might be able to influence how much your home is worth. Renovations that increase your home's value should raise your equity.
Is an equity release a good idea?
Releasing equity by refinancing or ‘topping up’ your mortgage can be a savvy way to turn past repayments and home price growth into usable cash for renovations, investing, or general life enjoyment. But remember, you’ll essentially be swapping home equity for new debt. That means your repayments may rise, your loan term can reset, and you could find yourself paying significantly more interest over time. The smartest use of released equity is often funnelling it into building wealth, perhaps by funding renovations that lift your property’s value or another appreciating asset, like an investment property.