Many investors and homeowners access the equity in their properties for a number of reasons. While there are a number of advantages, homeowners also need to be aware of the risks involved.
With the End of the Financial Year only a few weeks away, now is a great time to think about what you have planned for the next 12 months. Are you planning to expand your property portfolio or renovate your property? Accessing your equity could help you achieve this.
Firstly, equity is simply the difference between what you owe on the home loan and what the property is worth. For example, if you have a property that is worth $400,000 and you owe $250,000, your equity is $150,000. You can grow your equity by either the value of the property increasing or reducing how much you owe.
The quicker you are able to boost the equity in your home, the more options you will have financially. But what are the pros and cons of accessing your equity?
Access to extra money
Being able to access your equity without having to sell the property is one of the biggest advantages. The funds that you borrow are at home loan interest rates which can be a lot lower than other types of credit. The most common include purchasing another property, investing in shares and managed funds, car/boat purchase, overseas holiday or even funding a renovation.
Could boost value of home if money is used for renovation
Some homeowners access their equity to help fund a renovation. If done correctly, a home renovation can help boost a property's value even more than what is spent. It could also save you from having to upsize, saving you the cost and inconvenience of changing over properties.
However, renovating shouldn't be done on a whim without any research. Overcapitalisation is a common mistake for renovators who do not do their research and who are not careful with their budget. This is where the amount spent doesn’t increase the property’s value by the same amount. Speak to different professionals about what the most cost effective solutions are for adding value to your home.
Accessing equity is done via increasing how much you owe. It is still a loan with interest charged for using the funds. At the moment, you may be able to afford your current repayments, however, if you increase your home loan your repayments will increase.
Before applying, make sure you speak with your lender about your options and what the likely repayments will be. What will you be using the funds for? Will they generate income that will help meet the additional repayments like dividends or rental income? Will it be used for an asset that will be increasing or decreasing in value?
It is also important to think ahead of time and what your financial situation will be like in a few years. With interest rates at a record low, many borrowers may be able to afford an increase in repayments now, but what about when interest rates start to rise? It could put you in serious financial stress if you are unable to meet repayments.
If you are borrowing extra to invest, you need to consider how the risk is magnified. Borrowing allows you to invest money you wouldn’t normally have without saving the funds, but it also means that if the investment doesn’t give the return that you expect or you make a loss on your investment, then this loss is further compounded by having to pay interest on the funds in the first place. Always seek the advice of a qualified professional like an accountant or financial planner and understand the risks involved and how this fits with your risk profile.
Excessive interest if not repaid quickly
If you increase your home loan to purchase an item like a car, furniture or a holiday, it is important that you focus on repaying this debt as soon as possible. Although the interest rate is relatively low, these are items that don’t hold their value. Spreading a smaller purchase over a 25 or 30 year loan term will mean that you will end up paying thousands of extra dollars in interest. So if you do access your equity and increase your loan amount, speak to your lender about having this amount ‘split’ from your home loan or put into a separate account. This way it will still be under the same interest rate, however it will also have its own statements and repayments, so you don’t forget the debt is still there. You can then focus on paying this off quickly.
State Custodians has a range of home loans which can be divided into portions and also have features like offset accounts and free redraw. So, if you wish to keep your loan increase separate from your home loan in order to pay it off sooner, you can.
Before considering accessing your equity, it is vital that you seek the advice of a professional. As you will be increasing your debt, you will be exposed to higher risks. An accountant or financial adviser can give you expert advice about what options will suit your own personal situation.
The Lending Specialist team at State Custodians can talk you through the pro’s and con’s of accessing your equity, calculate the new repayments or compare your current interest rate to home loans that we can offer. Call now on 13 72 62 or leave your details here and they will contact you.