Home equity loan

Do you think you might need to borrow some extra money in the future? A home equity loan could be your best option.

Quick quote

Home equity loan

Home equity loans are a specific type of home loan. They allow you to access the equity (ownership) that you build up in your home over time. This can be important when your circumstances change.

What can you use a home equity loan for?

You can use a home equity loan for just about anything. Some of the most common are listed below.

  • Home renovations

Even though your home may suit your needs now, it may not over time. For example, as your kids get older if you start a family. Renovating a home can be cheaper than moving. It can also increase the value of your home, provided you don’t overcapitalise.

  • Debt consolidation

If you have other debts like personal loans or credit cards, you can consolidate them all into your home loan. This can help save you money because home loan interest rates are low. You therefore won’t be charged as much interest.

Debt consolidation also allows you to avoid the hassle of having to make multiple repayments. Instead you can just make your regular home loan repayment to cover all your debts.

  • Deposit on an investment property

Many Australians use the equity that they have in their own home as a deposit on an investment property. This can be a great way to build your long-term wealth.

  • Buying a business

Sick of your job? You can use a home equity loan to help you buy a business.

  • Buying a car

Home loan interest rates are cheaper than car loans.

How home equity loans work

Home equity loans are usually one of two types:

  • Line of credit

A line of credit home equity loan works like a credit card. You have a pre-approved limit that you can borrow against if you need to. You only get charged interest on the actual amount you borrow.               

  • A lump sum

A lump sum home equity loan allows you to borrow a  lump sum using your equity as security. The equity (ownership) that you have in your home can be easily calculated. It’s the difference between your home’s market value and what you owe on it. For example, suppose you have a home worth $600,000 and you owe $350,000 on your home loan. Your equity would be $250,000 (i.e. 600,000 less $350,000).

Your equity in your home can build up over time in three ways.

  • By your home increasing in value over time

As your home increases in value and the amount you owe on your home loan decreases, your equity further increases. History shows that Australian property prices tend to rise over the long term.

  • By you making your regular home loan repayments.

Every time you make a home loan repayment, part of the amount repays interest and part repays some of the principal. The principal is the amount you originally borrowed. 

  • By making additional home loan repayments.

You can do this by making voluntary one-off payments when you can. For example, when you get a tax refund. You can also do this by converting your monthly repayments to fortnightly or weekly instead.

How can making fortnightly or weekly home loan repayments increase my equity?

When you convert your monthly repayments to fortnightly or weekly, you make sure you pay the same yearly amount. You can do this by dividing your monthly repayments by 2 if you want to make fortnightly repayments. If you want to make weekly repayments, divide your monthly repayments by 4.

Either way, it will help you to make extra repayments and build your equity in your home. That’s because there are slightly more than 2 fortnights in each month and slightly more than 4 weeks. The result is that you end up making an extra monthly repayment each year without even realising it. The table below uses a simple example to demonstrate. 

Repayment Frequency Repayment Amount Total Yearly Repayments Total Yearly Extra Repayment
Monthly
$2,400
$28,800
$0
Fortnightly
$1,200
$31,200
$2,400
Weekly
$600
$31,200
$2,400

How much can you borrow with a home equity loan?

The amount you can borrow on a home equity loan depends on four main factors.

  • How much equity you have

The more equity you have, the more you’ll be able to borrow. 

  • Your lender’s policy

Different lenders will be prepared to lend different amounts. The amount your lender will approve will depend on their loan-to-value ratio (LVR) policy.

The LVR is the amount you owe expressed as a percentage of the value of your home. For example, if your home is worth $600,000 and you borrow $480,000, your LVR is 80% ($480,000 divided by $600,000). Some lenders may be prepared to accept higher maximum LVRs than others.

Some lenders may not approve a home equity loan higher than 80%. Others may be prepared to approve them for LVRs of 90% or 100%. However, the higher the LVR the lender is prepared to accept, the stricter the terms and conditions will be. For example, you’ll likely be charged higher interest rates and other additional fees with a high LVR.

  • Your ability to afford the additional repayments

If you increase the amount you owe, your repayments will increase to ensure you pay off your loan on time.  You can use our repayment calculator to work out your repayments for different loan amounts. You can also use our borrowing power calculator. It will give you an indicative idea of how much you may be able to borrow.   

  • Your credit score

If you have a good credit score, you’ll be more likely to be approved for any loan. This includes a home equity loan. Lenders check your credit score when you apply for a loan. You can develop a good credit score by making all your debt repayments on time.

The pros and cons of home equity loans

Are they a good idea? It depends on your individual financial situation and goals.

PROS

Home loan interest rates are lower than other forms of finance like personal loans or credit cards.

Home equity loans can help you with finance if your circumstances or needs change. It’s important to remember that a home loan is a long-term financial commitment. Standard home loan terms in Australia are 25 or 30 years. Your circumstances and needs are highly likely to change over such a long time. A home equity loan provides you with flexibility.

Home equity loans can help you to leverage your wealth if you borrow to invest in growth assets. For example, buying an investment property or a business. Both of these investments can help you to generate additional income and achieve capital growth. Capital growth is achieved when your assets increase in value over time.

Some lines of credit only require interest-only repayments. This can make your repayments more affordable.

CONS

When you borrow against your equity, you increase your debt. If you use the additional debt on expenses like a holiday or to buy depreciating assets, your wealth will decrease. Depreciating assets include cars. Their value decreases over time.

A home equity loan can have additional fees.

Your repayments will most likely increase. You should only borrow more if you can comfortably handle any extra repayment that’s necessary. Otherwise, you can potentially get yourself into a debt spiral.

Home equity loans involving lines of credit can tempt you to increase your debt if you aren’t financially disciplined.

If you increase the amount you owe, you increase your risk. You should always remember that a lender can repossess your home if you don’t make your repayments. Accessing your equity for risky purposes or frivolous spending can result in you losing your home.

Top tips to consider before accessing your home equity

Follow our top 3 tips before taking up home equity loans

Consider the potential for interest rate rises

Even though interest rates in Australia are at record lows now, there’s no guarantee they’ll stay low. Home loans are long-term financial commitments.

If you want to borrow more by accessing your home equity, always factor in the potential for future interest rate rises. You need to ensure you’ll be able to afford the additional repayments if it happens.

Make sure you have other funds set aside for emergencies

If you access all the equity in your home, what will you do if you have a financial emergency?

Talk to a licensed and independent financial planner

Accessing the equity in your home is a big financial decision, especially if you’re taking out a large lump sum. It’s best to seek independent financial advice about whether it’s a suitable option for you. This advice should be based on your specific financial circumstances and goals.

Frequently asked home equity loan questions

Need to know more? Here are answers to other common home equity loan questions we get here at Savvy.

Are there other names for home equity loans?

Yes. They can be called line of credit loans or second mortgages. They also include any home loan with redraw facilities. Reverse mortgages are also a type of home equity loan.

However, reverse mortgages are usually only available to retirees who own their own home. No repayments are required, unlike other forms of home equity loans.

What is lenders’ mortgage insurance (LMI)?

LMI is paid by borrowers to protect lenders. If you don’t make your repayments, the LMI covers the lender. Most lenders will require you to have LMI if your loan-to-value ratio (LVR) is higher than 80%.

Can I check my own credit score before I apply for a home equity loan?

Yes. Credit scores (also called credit ratings) are compiled by credit reporting agencies in Australia. You can check your credit score for free once a year.

What is serviceability?

Serviceability refers to your ability to make your home loan repayments. Lenders assess this before approving any loan. They consider the amount you borrow, your repayments, your income and your other expenses.

How long will it take me to increase my home equity?

There is no simple answer to this question, other than ‘it takes time’. It depends on property price movements and the loan repayments you make, especially additional repayments. The more repayments you make, the more equity you’ll have.

Can you use home equity loans to buy shares?

Yes, there are usually no restrictions on what you can use home equity loan finance for. Your home equity provides your lender with the loan security they need.

However, it’s important to understand that shares should be viewed as long-term investments. They have an element of risk because their value can fall as well as rise.

Who determines the value of my home for a home equity loan?

Your lender will usually get an independent valuation done. It’s important to understand that this valuation will usually be conservative to lower the lender’s risk.

Can I use an offset account with a home equity loan?

Yes, an offset account is available for home equity loans from most lenders. This can help to reduce your home loan interest.

However, it’s important to compare the benefits of an offset account with the cost. Many lenders charge fees for offset accounts. There is no point paying this fee if the benefits (interest savings) don’t outweigh the cost.

Do I have to formally apply to get additional funds with a home equity loan?

Yes and No.

If you want a lump sum, you’ll have to fill out some application paperwork. Your lender will want to assess your current financial circumstances and whether you can afford to access your equity.

But if you have a line of credit, you’ll be able to access your funds without any paperwork.

Is a home equity loan similar to refinancing?

It can be if you want to access a lump sum and your repayments will change. Your lender may suggest you refinance to a new loan with a longer term.