Have you ever thought of getting cash out of your home loan? It’s fairly common for Australians to use the value of their homes to access cash for various purposes. Two common forms of this finance option are home equity loans and lines of credit. If you’re unsure how these work, here’s a quick guide to getting cash out of your home and the potential benefits and risks.
What is home equity?
Home equity is simply the difference between the value of your home and what you owe on your mortgage. For example, if you owe $400,000 on your mortgage and your home is worth $700,000, your home equity is $300,000. When you want to get cash out of your home, lenders will use this value as security to increase the value of your mortgage or offer a separate financial product, such as a personal line of credit.
Lenders won’t lend the full amount of the equity but a percentage of the home’s value – usually 80%. This is known as the loan-to-value ratio (LVR).
In our example, the maximum loan amount would be $160,000, which is (0.80 x $700,000) – $400,000.
Once you determine that you have equity in your home, there are several options to get cash out.
Home equity loan
This type of loan is a popular way to get cash out of home loans. This can be done by adding to the mortgage (mortgage top-up) or getting a new mortgage with a different term. With a top-up, more debt is added to the existing mortgage. Not all mortgages are eligible for a top-up, so you might need a new mortgage to access equity.
When getting a new mortgage (refinancing), the new loan is used to pay out the older mortgage with additional funds available based on the equity. The term of this loan can be longer than the time left on the previous loan to avoid larger repayments.
Home equity loans can be used for a variety of purposes, including renovations, investment properties, vehicle purchases or taking a holiday.
Line of credit loan
This type of loan is separate from a mortgage. With a line of credit, you get a set limit on how much you can borrow. You don’t get the funds in a lump sum but draw from this amount as needed. For example, if your line of credit has a limit of $150,000 and you only use $20,000 of it, you only pay interest on the $20,000. Over time you can take funds out and pay them back without being on a fixed payment schedule, like with a mortgage.
You can use a line of credit for many things, including home renovations or purchasing a vehicle.
Pros and cons of using equity to get cash out of your home
Like any other finance product, home equity loans and lines of credit have pros and cons.
Interest rate – since lenders reduce risk by using the value of your home as security, the interest rates are lower than other forms of credit, such as car loans and credit cards. When a line of credit is based on home equity, the rate is lower than if the lender has no security (unsecured line of credit).
Increase wealth – if used for the right reasons, such as purchasing an investment property or renovating your home, your home equity can be used to increase your wealth. For example, if you spend $100,000 on a renovation, and increase your home’s value by $200,000, you have increased your home equity.
Flexibility – with a line of credit, your use of the funds and repayments are flexible. Note that lines of credit have loan terms of up to 15 years with some lenders (but most are shorter than this), so you will eventually need to repay what has been drawn from the credit line.
Higher repayments – with a new mortgage or a top-up, you will have higher repayments than with your original mortgage.
Lower home equity – once you increase your mortgage amount, your home equity will decrease, so you won’t have that equity if you need it in the future or until the value of your home increases. If you use your equity wisely – to renovate or purchase an investment property – you can improve your financial position.
Costs – new loans usually include fees, such as establishment fees. In addition, lenders will often want a professional property valuation to confirm the value of the property and the equity available.
Risk – a line of credit does not have scheduled payments, so an undisciplined borrower might be tempted to keep an ongoing balance and end up paying large amounts of interest on the outstanding funds over time.
Getting professional advice for accessing home equity
With many factors to consider when getting cash out of your home, you might not be sure about the best way forward. The team at Reduce Home Loans can show you the options and guide you through the process.
Get in touch with a lending expert at Reduce Home Loans for a better home loan experience and a great rate.
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