You do not have to sell to use the equity in your home. Find out how a home equity loan works.
Once you have equity in your property, you can access it for various purposes, including funding another investment property or renovating your home. A home equity loan is a convenient way to access this equity.
The most common type of home equity loan is a line of credit. It functions similarly to a credit card by allowing you to access funds as you need them up to a pre-approved credit limit. However, 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.
The more you know about home equity loans, the easier the decision will be to tap into your home's equity. Here are answers to some of the popular questions borrowers ask us.
How much equity do I need to qualify for a home equity loan?
It would be best if you had 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. For example, 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%.
Your home must be valued at a realistic price. If property values drop and your home has been valued at an inflated price, you may find you owe more on the mortgage than the home is worth. In addition, because your home secures the debt on your loan, your property is at risk if you fail to make the payments.
What can I use a home equity loan for?
There are many different uses for home equity loans. For example, you might want to purchase another property, invest in shares, renovate, buy a new car or start a business. As part of the application process, some lenders may ask you to prove the purpose of your loan, but this depends on the lender and the amount you need.
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.
Learn how much you can save through refinancing.
How do I access the money?
You can withdraw the funds quickly, usually through ATMs and EFTPOS. The money does not have to be used at once; you can access it when and where you need it. Sticking to a budget will help you resist the temptation to overspend.
How do the repayments work?
You are assessed for a home equity loan using similar criteria to a regular home loan. However, 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. In addition, 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.
What downsides should I be aware of?
It would be best to prepare for interest rate rises throughout the loan, so consider whether you have enough cash flow to act as a buffer.
Also, keep in mind that your loan will not get paid off over time if you are not paying off the principal. So if you do not force yourself to stick to a regular payment plan, there is the risk that you may still owe the same amount on your home loan as you started with ten years down the track.
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. Speak to your mortgage broker about ways to achieve this.
This article is prepared based on general information. It does not consider individual financial objectives or needs and is not financial product advice, and the content quoted from Yellow Brick Road Blog.