When you have a mortgage to pay off, it’s easy to feel like you need to go on complete financial lockdown. This can make it difficult to spend on often necessary things like home improvements or a new car, or to build additional wealth through investing. However, homeowners are actually in a unique position to access capital through the equity they already own from paying back their existing home loan.
This is because they are eligible for the home equity loan, an often untapped source of no deposit home loans. Read on for your ultimate guide to this kind of loan, including what it is, how you can apply for it and how to know if it’s right for you.
When many of us buy a property, we do not think about the property’s home equity and how this will grow over our years of ownership. Instead, we only focus on the amount we owe on the home, and how we can pay this off. But, the truth of the matter is this unused equity can be used to help you grow your wealth, providing you take advantage of it when the going is good. A home equity loan or equity loan enables you to borrow value that you’ve acquired in your home.
Home equity is the difference between what your home is worth and the amount you owe on your mortgage. A home equity loan allows you to access funds by borrowing against this balance through a lender.
If you have an existing property and have paid off more than 20% of your mortgage, you should be eligible for this loan in Australia. However, a poor credit score or encumbrances against your home (such as tax liens) may affect the outcome of your application.
The amount you can borrow depends on your property’s current market value and how much you have remaining on your home loan.
Yes, it’s entirely up to you what you spend your loan on. However, most borrowers use them for larger investments, such as home renovations, purchasing a new car, funding their business or building an investment portfolio. The loans are also commonly used for consolidating larger debts, such as your mortgage and credit card.
There are various steps involved in securing this type of loan. Firstly, you must calculate how much equity is available to you. You do so by subtracting the balance of your current loans from the estimated market value of your home, based on a real estate valuation or comparable properties in your area.
Then, you must determine the amount of equity you actually need and can access. Some key considerations here include:
Once you have determined the amount of funds you would like to unlock, it’s time to review your loan options.
At this point, it’s wise to contact one of eChoice’s qualified mortgage brokers. They will be able to assess which loan type and lender is right for you and help you minimise the fees involved. They will also be able to help you lodge your application. As well as providing documents like identification, proof of income and tax statements, you may also need to provide evidence for the purpose of your loan.
Home equity loans have many unique benefits which make them an attractive lending option. First, they tend to have a lower interest rate than credit cards and other types of personal loans.
Another major selling point is the loan’s flexibility. You can use a home equity loan for any purpose and access it whenever you need. The funds can usually be easily accessed via ATM card, online banking or cheque. In many cases, you also don’t need to repay it until you reach your credit limit. You also have the flexibility to make additional payments on the loan at any time, to get it paid off faster.
If you have paid off at least 20% of your mortgage and don’t have any encumbrances against your property, securing a home equity loan should be relatively quick and easy. However, it can become more of a challenge if you have a poor credit rating. So, what credit score do you need to get a home equity loan? While there’s no hard and fast rule, a credit score lower than 620 may present additional challenges. You may want to work on improving your credit score by paying back all current financial obligations on time.
Yes, if you have paid off your home in full, you are in a favourable position to get a home equity loan. However, you will still only be able to access 80 to 90% of your home’s value.
Many Australian homeowners have more equity in their home than they realise, and do not use it to their advantage. However, it’s important to note that home equity loans are not for everyone, and you must have strong financial management skills to avoid getting into further debt.
First, you’ll need to find out how much equity you have to use. Consider completing a property valuation to find out how much your property is worth, and then subtract the value of your mortgage from that value to find out how much equity you have. This money can then go towards placing a deposit on a second property. Your first home will be able to function as safety net for the debt on your second property, and you might not need a cash deposit when purchasing the second property.
There are various ways you can access you home’s equity to buy a second home. Some of the ways include:
Investment related expenses are usually tax-deductible. For instance, interest repayments on investment properties are generally tax deductible. If you’re taking out a line of credit loan this could prove advantageous. This is because these types of loans are interest-only and only require you to pay interest on the loan until the point that you reach your credit limit.
Home equity loans and cash-out refinances are similar, in that they allow you to access the equity you have accumulated in your home. However, a cash-out refinance replaces your current loan with a new term, while a home equity loan is an additional payment to make. So, how do you know which one is right for you? It depends on your mortgage rate. If you can get a better interest rate on your mortgage rate and get additional cash-out, refinancing may be the way to go. If the current rates are higher than your existing mortgage rate, a home equity loan may be the more suitable option.
Refinancing may allow you to enjoy a lower interest rate on your equity loan or may provide you with more favourable terms. However, in a similar vein to refinancing a typical loan, there would be risks involved. You may be subject to closing costs or if you’re unable to pay your new loan, you may even lose your home. It may be useful to consider how much your home is worth and your credit history when making this decision to refinance.
Home equity and personal loans both come with their own advantages and disadvantages. Home equity loans generally have much lower interest rates than personal loans. They are also usually spread out over a much longer period of time – 25 or 30 years, compared to a maximum of seven years for a personal loan. However, personal loans tend to be easier to manage, as they generally have minimum monthly repayments you need to pay in order to keep up with them. If you are looking for a flexible lending solution and are financially disciplined, you may save some money in going for a home equity loan. Otherwise, you may want to stick to another type of personal loan.
There are typically two types of home equity loans – a lump sum cash loan or a line of credit loan. A lump sum loan allows you to receive a lump sum for an investment or project. However, you will start paying interest immediately on this type of loan and for the full sum borrowed, even if you haven’t used it for its purpose.
Conversely, a line of credit loan is separate to your existing home loan, but is taken out against your property. This type of loan works like a giant credit card, where you can draw out the funds as needed. Therefore, you only pay interest on the amount of money that you have used. This method gives you greater flexibility, but it may also attract higher interest rates, and can be a trap if you do not manage your spending. It’s best to chat to your broker or financial adviser to determine which type of loan is for you.
As with other mortgage loans, there are closing costs associated with both home equity loans and home equity lines of credit. The amount will depend on your specific lender, and the amount you have borrowed.
A home equity loan may slightly decrease your credit score, but generally not enough to impact your ability to secure future loans. In a study, LendingTree looked at data from 2500 consumers to determine how their credit scores changed in the months after they took out a home equity loan.
They found that their scores declined by around 13 points, which would have a negligible impact on the average credit rating of 735. So, provided your Home Equity Loan application isn’t rejected and you make your repayments on time, it’s not likely to significantly impact your credit score.
In this scenario, it is the purpose of the loan that matters. In order for loan interest to be considered tax deductible, it must be used to produce income. The next consideration would be what you are using this income for. For instance, it is unlikely that it will be tax deductible if you used this income for the purchase of a residential property. However, it could be tax deductible if you were using it on an investment property.
If you are a retiree, you technically can get a equity loan. However it may be more difficult since your income will be lower and therefore you’ll have a lower bargaining power. You may need to show proof that you’re capable of making these repayments, such as evidence of an ongoing stream of income. Payments from your equity loan may also have an impact on your eligibility for pension funds. As well as this, you’ll need to make sure you are financially strong enough to make the repayments for your loan. Because of this, getting a ‘seniors equity loan’ or a reverse mortgage is a popular option amongst retirees.
Technically, it is possible to have two lines of credit on the same home. However, you would need to ensure you have enough equity in your home to support the loans. As home equity loans are flexible in terms of how and when you spend them, it’s also unlikely you would need to take our two separate lines of credit for different purposes.
Yes, just like any type of credit, you must pay back this loan within the timeframe laid out in your terms. Failure to do so can result in legal action or in a lender taking your property as payment. However, you generally have a much longer time to pay back a home equity loan, as well as more flexible terms around repayment.
If you’re thinking of investing in another property, the brokers at eChoice are here to help! Contact us today and we’ll find you a competitive mortgage rate.
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