If you’re paying off a mortgage on your own home or an investment property, it’s likely you could have some home equity. When used correctly, your home equity could potentially be a surprisingly useful financial tool.
The word ‘equity’ means ownership. Your home equity refers to the amount of ownership you’ve built up in your home’s value.
Calculating your home equity
The amount of home equity you have is calculated by determining the market value of your home and then deducting the amount outstanding on your mortgage.
For example, if your home’s market value is $400,000 and your mortgage balance is $300,000, then your home equity is $100,000.
Building your home equity
There are really only two ways to build your home equity: repay debt or improve market value.
Reduce debt: The first option for building home equity is to repay the amount you owe on your home mortgage balance. As your balance is reduced, the difference between your property value and outstanding debt increases.
Keep in mind that most owner-occupied home loans use an amortized principal-and-interest repayment. This means a portion of every payment you make covers interest charged, and the remaining portion reduces your outstanding balance a little more. Effectively, every payment you make is increasing the amount of equity you have in your property.
However, if your mortgage is an interest-only loan you won’t build equity the same way. Every payment you make only covers the interest charged, so you’re not reducing your balance at all. You’ll need to make extra payments to begin paying down the amount you owe.
Increase market value: The other option is for the property’s value to increase in response to market conditions. In some cases, a property’s value might increase naturally over time due to increases in demand within the real estate market.
Some people are able to manufacture additional home equity by completing home improvements or renovations designed to increase the property’s market value.
Accessing home equity as a financial tool
The equity you build in a property is an asset that has the potential to be used as a financial tool. There are several ways to put your equity to good use, including:
- Borrow against equity: Some homeowners are happy to borrow more money against the equity they’ve built up in their homes to fund other purchases. Some may choose to use the money to pay for renovations to improve the property’s value further. Others may decide to use the funds to pay for lifestyle items, such as travel or a new car.
- Deposit on an investment property: It’s possible to access the equity in your home to use as a deposit to purchase an investment property. You’re effectively using your home equity to expand your property portfolio and creating a source of rental income at the same time that might be used to help repay the loan amount. The money you draw down from your family home to purchase an investment property is tax effective. However, any remaining debt on your own home is not.
- Fund retirement: Some people may have worked hard for years to repay their home mortgage, but during retirement it could be possible to access some of the equity in the property to help fund or supplement your retirement income. Reverse mortgages allow retirees to access a small portion of the equity available to be spent on anything they want. There are no repayments to worry about, as these types of loans are paid after the homeowner leaves the house. Reverse mortgages are complicated, so it’s important to seek professional advice to ensure they’re right for your situation.
Before accessing your home equity, take the time to speak to an Assured mortgage broker about your options.