Pros and cons of accessing home loan equity
Home equity loans allow homeowners and investors to borrow equity in their homes, giving them easy access to cash. However, owners also need to be aware of the risks.
Are you planning to expand your property portfolio or renovate your property? Accessing your property's equity could help you achieve this.
Equity is simply the difference between what you owe on the home loan and what the property is worth. For example, if you have a property valued at $600,000 and a loan of $400,000, then you have $200,000 equity.
Equity can grow when the property value increases or your debt reduces, and is an asset you can use for other purposes – such as investing, renovating or moving house. There are pros and cons to consider though.
Using equity to access money
You can get money out of your property without having to sell it, borrowed from your lender at home loan interest rates that are generally lower than other types of credit.
The most common uses of equity include purchasing another property, investing in shares and managed funds, car/boat purchase, overseas holidays, and funding a renovation. In the case of purchasing an investment property, the deposit-saving process can be avoided by using the equity in your existing home.
Renovations can boost your property's value
Accessing equity to help fund a renovation could, if done correctly, boost a property's value by more than the outlay. It could also save you from having to upsize, saving the cost and inconvenience of selling, buying and moving.
Renovators looking to increase their property value need to take care to avoid overcapitalisation, which is when the renovations cost more than the value they add to the property.
Increased mortgage repayments
Accessing your property's equity increases the amount you owe on your mortgage. Even if interest is lower than other forms of consumer credit, it is still a debt with interest charged, and repayments may also increase if the total loan amount increases. A home equity loan could be a bad idea if it will overburden your finances or shift debts around.
Before applying, make sure you speak with your lender or broker about your options and what the likely repayments will be. What will you be using the funds for? Will your use of the funds generate income that will help meet the additional repayments, such as dividends or rental income? Will it be used for an asset that will increase or decrease in value?
It is also important to think ahead about your future financial situation. Interest rates are currently low, but consider your ability to afford repayments without financial stress if interest rates increased.
Taking on increased risk
If you are borrowing extra to invest, you need to consider how the risk is magnified. While all loans carry some level of risk, the fact that home equity loans are tied to the home means they should be approached with caution.
Borrowing allows you to invest money you wouldn't normally have without saving the funds, but it also means that if the investment doesn't give the return that you expect or you make a loss on your investment, then this loss is further compounded by having to pay interest on the funds in the first place.
Always seek the advice of a qualified professional like an accountant or financial planner and understand the risks involved and how they fit with your risk profile.
Excessive interest if not repaid quickly
If you increase your home loan to purchase an item like a car, furniture or a holiday, it is important that you focus on repaying this debt as soon as possible. Although the interest rate is relatively low, these are items that don't hold their value. Spreading a smaller purchase over a 25– or 30-year loan term will mean that you will end up paying thousands of extra dollars in interest.
If you do access your equity and increase your loan amount, speak to your lender about having this amount 'split' from your home loan or put into a separate account. This way it will still be under the same interest rate, however you can focus on paying that amount off separately to (and at a faster rate than) your home loan.
Before considering accessing your equity, seek professional advice. As you will be increasing your debt, you will be exposed to higher risks. An accountant or financial adviser can give you expert advice about what options will suit your own personal situation.
This material has been prepared for information purposes only. This should not be taken as constituting professional advice. You should consider seeking independent legal, financial, taxation or other advice to determine how this information relates to your own circumstances.