Once you have equity built up within your home, you can access it for a number of different uses including funding another investment property or renovating your home through a home equity loan.
Much like a credit card, a home equity loan is a line of credit that allows you to access funds up to a pre-approved credit limit. You only pay interest on what you borrow, and there is no obligation to pay any of the principal until you reach the credit limit.
A line of credit can be taken out as a new standalone home loan or you can split your current home loan with a line of credit facility.
Here are some frequently asked questions by borrowers.
You should have at least 20% equity in your home to consider taking out a home equity loan. If you try to borrow more than 80% loan-to-value (LVR), you may have to pay lenders mortgage insurance (LMI) – even if you have paid it before on your original loan.
To calculate equity, take the value of your home and minus the amount you owe on it. If your home is valued at $850,000 and you still owe $650,000 on your mortgage, you have $200,000 in equity or 23%. In this example, the loan-to-value ratio is 76%.
There are many different uses for home equity loans. You might want to purchase another property, invest in shares, renovate, buy a new car or start a business.
Home equity loans usually attract higher interest rates than traditional variable rate loans, but in most cases, they are still cheaper than credit cards or personal loans.
You can withdraw the funds easily, usually through ATMs and EFTPOS. The money doesn’t have to be used at once, you can access it when and where you need it.
You are assessed for a home equity loan using similar criteria to a regular home loan. The lender sets the credit limit and principal repayments are only required once this limit has been reached.
Each month you are required to make the minimum interest-only repayments, with the option to make principal and interest repayments if you choose. The terms of repayments are flexible, allowing you to make additional repayments without restriction.
Interest is charged only on the money you use, not on the total amount of the available credit. This means you can lower your interest charges by accessing your funds as you need them rather than using all the money at once.
You need to prepare for interest rate rises over the course of the loan, so consider whether you have enough cash flow to act as a buffer.
Also keep in mind that if you’re not paying off the principal, your loan will not get paid off over time. If you don’t force yourself to stick to a regular payment plan, there is the risk that ten years down the track you may still owe the same amount on your home loan as you started with.
The best way to use this type of loan is to maintain the maximum amount of money within your line of credit at all times.
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