What Is Equity, And Why Is It Important?

27 April 2018
If you’re currently paying off a home loan, or are looking at taking one out, it’s important you understand equity. Here’s a quick guide.

Equity plays an important role in any sort of secured loan, but is particularly pertinent in the case of home loans because they’re generally larger and take longer to pay off than, say, a car loan. The amount of equity you have in an asset used to secure a loan can affect the interest rate charged by the bank, and can also affect both your personal wealth and day-to-day finances.

What is equity?

Equity is essentially the difference between the value of an asset, such as your home, and how much you still owe on your mortgage. It represents the proportion of your home that you more or less own. So if your home is worth $600,000 and you still owe $300,000 on your mortgage, you have $300,000 worth of equity in your home.

However, equity doesn’t only grow as you pay down your debt – if your property appreciates in value, your equity in the property should also increases. While the size of your loan won’t have changed, the proportion of your home that you own will have increased, meaning a more favourable asset-to-debt ratio.

Equity – what is it good for?

Of course you’ll progressively acquire more equity in your home over the term of your loan, but the ramifications of increasing your equity and decreasing the amount you owe are significant. The more you reduce the principal of your loan, the less interest you pay; and the less interest you need to pay, the more your payment works to reduce the principal. You can see this in effect by using our Mortgage Repayment and Extra Home Loan Repayments calculators.

Additionally, depending on the terms and conditions of your home loan you may be able to make use of your equity in other ways, including:

  • Home renovations or repairs
  • Security against a new loan (a popular strategy among property investors)
  • Investing in shares or managed funds
  • Miscellaneous lifestyle expenditures, such as buying a car or boat.

Common ways of accessing home loan equity include the use of an offset account or redraw facility – make sure you know the difference.

The table below displays a snapshot of variable rate home loan products which can come with either an offset account or redraw facility available for people buying their next home on Canstar’s database, with links to providers’ websites. The table is sorted by the current advertised interest rate (lowest to highest), then by provider name (alphabetically).

The products and Star Ratings displayed are based on a loan amount of $350,000 in NSW at 80% LVR and available for principal and interest repayments. Read the Comparison Rate Warning.

Things to consider before borrowing against your equity

Making use of your equity as a way of gaining access to additional funds is a rather attractive prospect for many, but consider the following before rushing into your local bank branch.

  1. Approval isn’t guaranteed. You might already be daydreaming about that second home, but most, if not all lenders won’t just blindly sign off on you borrowing additional funds secured against your equity. They’ll most likely have a look at several factors including your current income, day-to-day expenses, and your remaining outstanding debt.
  2. Debt is debt. While additional borrowing secured against your equity can be seen as a ‘safer’ way of borrowing money than say, a credit card or line of credit, you’re still taking on additional (and potentially unnecessary) debt. A good rule of thumb is to only borrow against your equity if you’re seeking to build wealth, such as improving the value of your home or investing in a second home.
  3. Fees. Some lenders may charge fees on any additional lending you require, so be sure to explore the fine print of your loan before taking any action.

While we previously touted the benefits of increased equity as a way of paying less in interest on your home loan, it’s important you’ve got a good interest rate to begin with. You can do this by comparing different home loans with Canstar, to find the one that offers you both the best rate and the best value.

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