What is home equity & what is it good for?

If you have home equity and you sell your property, you'll likely walk away with money in your pocket – perhaps a significant amount too. But you don't necessarily have to sell up to access home equity.

You might turn to a home equity loan instead.

What is home equity? 

Home equity is the difference between the value of your mortgage and the value of your home. It's essentially the portion of your home's value that you own outright.

Home equity is the most valuable asset a typical homeowner holds, coming in above superannuation, according to the latest Household, Income, and Labour Dynamics in Australia (HILDA) Survey.

As of 2022, nearly 65% of households owned their home. Considering all households, the median home equity held was more than $520,000 (the median household owned $659,000 worth of property and $138,700 worth of home loan debt).

That's a decent chunk of change, and likely an amount that could make or break an investment strategy or provide a wealth of happiness.

However, home equity isn't cash money. It's tied up in bricks and mortar and, unless you choose to sell your property, the only way you can access it is to borrow against it.

What is a home equity loan?

A home equity loan is a name for a loan product secured against the equity built up in a person's home. This might be a second mortgage, or a secured personal loan, or, perhaps most commonly, a refinanced home loan.

Refinancing a home loan means to take out a new mortgage facility and use it to pay off an old mortgage facility. During this process, you might be able to increase the size of your home loan in order to access equity. Let's use an example:

Jill bought her house five years ago for $400,000 and borrowed $350,000 to do so. She has since repaid $50,000 of her mortgage and her home's value has risen to $600,000. That leaves Jill with $300,000 of equity.

Jill has decided she wants to do some home renovations and her builder has quoted $100,000 for the works. To pay for the renovations, she might choose to refinance her home loan. If she were to refinance to a new loan worth $400,000, she would be left with $100,000 of cash to spend.

Considering refinancing your mortgage? Check out some of the most competitive refinancing deals on the market:

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Benefits of a home equity loan

Accessing your home equity through a home loan can offer several advantages over taking out additional consumer debt. Some key benefits include:

• Lower interest rates
  Since home equity loans are secured against your property, they often come with lower interest rates compared to unsecured personal loans or credit cards.

• Large borrowing potential
  Depending on the equity available and your borrowing capacity, you may be able to access a substantial amount of funds.

• Flexible use of funds
  Homeowners might use equity for renovations, property investment, education costs, debt consolidation, to start a business, or to invest in shares.

• Improved loan terms
  If you refinance your mortgage while accessing equity, you may also benefit from a lower interest rate, fewer fees, or more flexible repayment options.

• No need to sell your home
  Unlike selling a property to access capital, borrowing against home equity lets you stay in your home while using its value to fund other goals.

Drawbacks of home equity loans

While borrowing against your home equity can be a powerful financial tool, it's not without risks. Some key downsides include:

• Increased debt
  A higher loan balance means you'll pay more interest over time, even if you secure a lower rate.

• Risk losing your home
  If you're unable to meet the higher repayments, your home could be at risk of repossession.

• Equity can fluctuate
  Property prices rise and fall – if your home's value decreases, you may find yourself with less equity than expected or even owing more than your home is worth.

• Additional costs
  Refinancing or taking out a home equity loan may come with fees, such as application fees, break fees, or lender's mortgage insurance (LMI) if your total borrowing exceeds 80% of the home's value.

Other ways to borrow against home equity

A home equity loan isn't the only way to tap into the value of your home. Some other options include:

Line of credit home loans

While not super common, line of credit home loans allow homeowners to borrow money as needed up to a set limit, rather than taking a lump sum upfront. This can be useful for ongoing expenses like renovations or investment opportunities.

• Pros: Flexibility to access funds when needed, interest-only payments available

• Cons: Higher interest rates than standard home loans, requires financial discipline

Home loan top ups

Some lenders allow homeowners to top up their existing home loan rather than refinancing or taking out a separate loan. This means borrowing more through the same home loan agreement, which can be simpler and more cost-effective.

The extra funds are added to your current loan balance and repaid under the same terms.

• Pros: Simpler than refinancing, no need for a new loan application

• Cons: Can extend your loan term and increase repayments

What can you use home equity to fund?

Once you've built up equity in your home, you can use it to fund a range of expenses – whether to build wealth, improve your property, or cover major life costs.

Using home equity to invest

One of the most common uses of home equity is an investment.

Many homeowners use their equity as a deposit for an investment property, helping them expand their portfolio without needing to save a large lump sum.

Others use it to invest in shares or managed funds, or even to start or grow a business by accessing capital.

Using home equity for renovations

Another popular reason to tap into home equity is for renovations and home improvements. Upgrading kitchens and bathrooms, adding an extra bedroom, or improving energy efficiency can increase your home's value while enhancing your living experience.

One positive aspect of using home equity to renovate is that doing so might grow your property's value, thereby growing your equity further.

Using home equity for personal and lifestyle expenses

Some homeowners choose to access equity for personal goals and lifestyle expenses.

These might include a dream holiday, paying for private school or university fees, or unexpected medical costs.

Others may use equity to consolidate debts, rolling multiple loans into a single home loan with a lower interest rate, which can help reduce repayments and simplify finances.

While home equity can be a powerful financial tool, it's important to use it wisely. Borrowing against your property can be beneficial if it increases wealth or financial stability, but funding short-term luxuries using wealth built over the long term could put unnecessary strain on your finances.