Equity grows in two ways: through your loan repayments reducing the outstanding balance, and through the property increasing in value. In practice, both happen simultaneously over time - you chip away at the debt while the property appreciates.
Early in a loan, most of each repayment covers interest rather than principal, so equity builds slowly at first. As the loan matures and the balance reduces, each repayment puts a larger proportion toward principal. Making extra repayments accelerates this process significantly.
Capital growth also contributes. A property bought for $550,000 that is now worth $700,000 has gained $150,000 in equity from market appreciation alone, independent of any repayments made.
Most lenders will not let you access your total equity. They apply a maximum loan-to-value ratio (LVR) - typically 80% of the property value - which protects against a fall in property values leaving you owing more than the property is worth.
Some lenders will go above 80% LVR, but Lenders Mortgage Insurance (LMI) applies in most cases above that threshold. Whether paying LMI is worthwhile depends on what you plan to do with the equity and the numbers involved.
Equity is most commonly used to fund an investment property purchase. Rather than saving a cash deposit, you use the equity in your existing home as the deposit (and sometimes the costs) for the new purchase. This allows you to enter the investment market without liquidating other assets.
Renovation is another popular use. Accessing equity to add value to your home - through a kitchen, extension, or additional bedroom - can make strategic sense if the renovation cost is less than the value it adds to the property.
Some homeowners use equity to consolidate higher-interest debts - credit cards, personal loans - into their home loan at a lower rate. This can reduce monthly repayments, but it converts short-term debt into long-term secured debt, so the total interest paid over the life of the loan can be higher. A broker can model this for your specific situation.
Helping adult children buy their first home is increasingly common, either by acting as guarantor (using your property as additional security) or by releasing equity as a cash gift toward their deposit.
There are two main ways to access equity. The first is to refinance your existing loan to a larger amount with the same or a different lender - the additional funds represent the equity you are accessing. The second is a loan top-up, where your existing lender increases your current loan limit without a full refinance.
A separate loan split is also possible - your broker sets up an additional loan amount secured against the same property. This is useful when you want to keep the equity funds clearly separated from your home loan for accounting or tax purposes.
Before you access equity, your lender will require an up-to-date property valuation and will assess whether you can service the increased debt. Your broker coordinates this process and can compare lenders to find the best structure for your purpose.
Jason and Steve are Adelaide mortgage brokers who give honest advice at no cost to you. No obligation.
The information on this page is general in nature and does not constitute financial advice. Given Finance Pty Ltd (t/a Lendology) ACN 624 144 501 is authorised under LMG Broker Services Pty Ltd ACL 517192.