• Understanding Equity

    Understanding Equity

    What is Equity?

    Purchasing a property is often looked at as a way of securing a stable place to live, in a location that suits you, but it can also be a valuable investment.  Here, we explain the term equity, and how this may relate to a property you own as well as its potential uses. 

    Since you purchased your property, it may have increased in value and is now worth more than what you bought it for. If this is the case, then the difference between what it is currently worth and what you still currently owe is referred to as equity. 

    You may be able to borrow a portion of this equity from your home loan provider which can be used for a range of purposes, such as putting it towards the purchase of an investment property, or investing in other assets such as shares.

    How is Usable Equity Calculated?

    When you first purchased your property, you would have only been able to borrow a percentage from your home loan provider, and would have been required to contribute the rest as a deposit from your savings. 

    For standard home loan applications, you are usually allowed to borrow up to 80% of the value of the property without the need to pay Lender’s Mortgage Insurance (LMI), the same may be true once your property had appreciated in value. 

    Of course, to find out the exact amount of usable equity that you may have, your property will need to undergo a valuation, and you should speak to a home loan specialist about your borrowing capacity.

    To help explain how this works, here is an example of a situation in which a couple has calculated their rough usable equity in their family home.

    Example 

    • Bruce and Rachel purchased their family home for $650,000. At the time, they borrowed $520,000 (80%) from their home loan provider, and provided a deposit from their savings of $130,000 (20%).
    • 2 years later, their property has increased value to $800,000. They have also paid down their loan to $500,000.
    • This has given them equity of $300,000, taking the current value of the property, and subtracting what they still currently owe on it.
    • Their home loan provider will allow them to borrow up to a total of 80% of the current value of the property ($800,000) without needing to pay LMI. This means that they may be able borrow additional funds referred to as usable equity provided they have sufficient income and approved financial circumstances for additional borrowing from their home loan provider.
    • Their usable equity was calculated by making the following estimate: $800,000 (current value of property) x 80% (percentage allowed by home loan provider) – $500,000 (existing loan) = $140,000 (usable equity). 

    Using Equity for an Investment Property 

    If you are able to borrow additional funds against your existing home, these may be used towards the purchase of an investment property. 

    If you have sufficient borrowing capacity, this may mean that you could borrow the full purchase price of the new property meaning you may not need to use your savings, like you would if it was your first property purchase. 

    Example

    Bruce and Rachel have decided to access their $140,000 usable equity from their family home to purchase an investment property. Here are a few points to summarise their purchase.  

    • The new investment property has a purchase price of $400,000. 
    • Instead of providing savings for a deposit, Bruce and Rachel will be using their usable equity to supply a 20% deposit of $80,000. 
    • They will borrow the full $400,000 needed for the purchase. This consists of $80,000 (usable equity) + $320,000 (loan secured by investment property). 
    • After the settlement of the investment property, they will have a loan of $500,000 for their family home, and a loan of $400,000 for the investment.  

    Please note, that the cost of stamp duty, legal fees and other associated costs should be considered in your total required funds.

     

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    About the author

    • Raymond

      Raymond A Ram is the RAMbassador for RAMS Financial Group. Raymond works with the RAMS team to bring simple, helpful and expert information on home loans and savings accounts to life with his down to earth and cheeky personality. He enjoys seeing everyday Australians turn their dreams of saving for a goal or getting into a home a reality. 

      Growing up in Goulburn, NSW, Raymond was brought up with good old-fashioned Aussie values of hard work and a fair go. It soon became apparent that Raymond wasn't content for the conventional path of grazing, producing the very best wool, and finding a nice sheep to settle down with. So it wasn't long before his passion for performing and his talent as a likeable larrikin shone through - landing him a few roles such as 'RAMlet'. He was even tipped to play RAM-bo at one point but chose to become star of the small screen instead as RAMbassador for RAMS. He now finds this role so much more rewarding.

      Contact your local RAMS Home Loan Centre about your home loan options.

      Raymond A Ram
     

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  • Disclaimer:

    The information here is of a general nature only and is not intended to constitute financial or tax advice. You should consult your professional adviser, accountant or taxation expert for advice specific to your personal circumstances.

    The views and opinions expressed in this article are those of the author alone and do not necessarily represent the views or opinions of RAMS Financial Group Pty Ltd ABN 30 105 207 538 (RAMS),  Westpac Banking Corporation ABN 33 007 457 141 (Westpac) or their related bodies corporate. This article is strictly for information purposes only and neither RAMS, Westpac nor any of their related bodies corporate make any representation as to the accuracy or completeness of the information in this article or endorse the views expressed in it.