Equity is the difference between the value of your home and the amount you owe on it.
There are two main ways to build equity in your home. Your equity increases:
- as you pay off your home loan, or
- if the value of your home increases.
You can control the amount of your loan based on the repayments you make. If you pay more than the monthly minimum repayments for example, you are reducing the amount of your loan and increasing equity. As you pay off more of your home loan, your equity increases. It can take many years to build equity.
The value of your home will be based on the general conditions of the property market, the standard of your home and the value added improvements you make to your home. You can find out the value of your home at any time.
Equity and refinancing
Equity becomes very important if you are considering refinancing your loan and are investigating different lenders.
The amount of equity you have in your home will give lenders an indicative loan to valuation ratio (LVR). If your LVR is high, for example, if your loan amount is more than 80% of your property value, your new lender may require lender’s mortgage insurance to offset their risk. This will be an additional cost for you to incur. The interest rate of your new loan may also be determined by your LVR.
Lender’s mortgage insurance
It is a fairly standard banking industry practice to charge lender’s mortgage insurance (LMI) if your LVR is above 80%. LMI is an insurance that protects the lender, not the borrower. If your new lender is going to charge LMI, you may have the option of paying the premium up front otherwise it can usually be capitalised to your home loan amount, to be paid off each month.
Given LMI can cost thousands of dollars, this may represent a significant additional cost to your new loan.
You can read more about LMI on our blog post What is Lenders' Mortgage Insurance?
Brett had his home valued and it is currently worth $400,000. He has had his home loan for ten years and has an amount owing of $300,000. Brett's equity is $100,000.
Brett's new lender can do a loan for the amount owing. His LVR is the loan amount divided by the value of his house. Brett's LVR is $300,000/$400,000, which gives a LVR of 75%.
Remember, one factor in estimating the equity in your home is the current value of your property. The value of your home is difficult to control since house values are affected by the fluctuations of the property market.
If the property market experiences a drop, homeowners may have little or no equity in their home. That is, the current value of the home may be less than the amount owed.
This is particularly relevant for new homeowners as it takes time, often up to ten years, to see a significant reduction the amount owing on a home loan. If the loan amount is not yet reduced significantly, and property values are not increasing, then there may not be much equity in the loan.
This can make refinancing difficult.
Kim and Dave's situation
Kim and Dave bought their home three years ago. Their loan was for $300,000 and they currently owe $290,000. They are looking into refinancing and arrange for a property valuation of their home at today's prices. The valuation comes back at $265,000. Prices have dropped since they purchased their home. Since the valuation is less than the loan amount, Kim and Dave do not have any equity in their home. They decide to wait and review the property market in three years’ time.
What is your property worth?
You can get your property valued at any time to find out how much your home is valued at, in today’s prices. You may also want to do some of your own research on the property market. Read more at How property prices impact your home loan
Plan your move
Home ownership is a long term goal. You may find it worthwhile making a three to five year plan for your home loan, whether you are just starting out or if you are considering refinancing your loan. Take some time to consider your options.
Keystart is a transitional lender. We kick-start our customer’s journey into home ownership with our low deposit home loans. We also encourage our customers to move to another lender when they are ready. Once you begin to build some equity in your home, you may be able to get a better deal from another lender in the long term. This can include better interest rates, offset accounts and a number of other benefits that you can’t get with Keystart.
Once you have considered your equity, you may feel that the time is not right for you to refinance. This can be a frustrating decision. Your hard work has not been a waste of time though. You can use the information you now have to build a plan. Can you calculate or estimate a time when you may have enough equity to refinance? Create a three, five or ten year plan to put yourself back in control of your home loan.
Keystart recommends that you seek your own independent financial advice prior to making any decisions about your financial needs. The examples given in this post are provided for illustrative purposes only.