How to build wealth through home equity loans

Before we get into how you can build wealth through home equity, let’s first clarify what home equity actually is. Equity is the difference between what your home is worth and how much you still owe on your mortgage. For example, if your home is worth $700,000 and you still owe $300,000, your total equity would be $400,000.

Keep in mind, these calculations are merely a guide as the value of your home changes over time, so you can’t actually pinpoint a property’s true value until you sell it.

Your home equity typically builds over time, as you pay off your mortgage and as your property value increases. Generally speaking, the longer you’ve been repaying your loan, the higher your home equity should be.

A home equity loan allows you to borrow money against the equity you’ve built up on your property. The funds you borrow are secured against the value of your property, the same way your original mortgage is.

There are various ways you can access the equity of your home, as outlined below.

• A line of credit loan: this allows you to withdraw funds up to an approved limit based on your home equity, and only pay interest on the funds you’ve withdrawn.
• Using a redraw facility: if you have this home loan feature, you should be able to access funds that you’ve contributed to your mortgage through extra repayments.
• Refinancing your mortgage: this may allow you to restructure your home loan and take advantage of your accumulated home equity.
• Home loan top-up (or loan increase): an alternative to refinancing, you might be able to stick with your current loan and lender by getting a home loan top up. A home loan top up allows you to free up funds by extending your borrowing limit.
• Reverse mortgage: Australian home owners aged 60 or above may be able to borrow some of their equity through a reverse mortgage. Interest is charged on what you borrow, and you repay the debt when you sell the property or pass away.

The key to building wealth with a home equity loan is putting the funds towards money-making initiatives, such as investments or renovations.

Investing in a rental property

Depending on the size of your home equity loan, you may be able to put a deposit on a new property and turn it into a rental. Buying a home and renting it out is a popular source of capital growth, income and tax benefits such as negative gearing.

Renovating your home

Upgrading certain parts of your property can boost its overall value, which means if you decide to sell it down the line you may make more money - creating more wealth for you. 

By renovating with funds from a home equity loan, you’re essentially using your home’s own equity to improve its worth.

If you decide to renovate your home for selling purposes, it’s important to hit the calculator and work out how much value it might actually add to your property and whether it’s worth the investment, as you don’t want to run the risk of overcapitalising, i.e. putting more money in than what you’ll get back.

Investing in the share market

Another way to use your home equity to grow your wealth is by investing in the share market. The shares you choose (individual stocks, managed funds or exchange-traded funds), and how much you put into them, is up to you but it’s worth doing some research before you jump in.

There’s no concrete answer as to how much you can borrow as part of a home equity loan. This is because your borrowing power depends on a number of factors including your assets, financial circumstances and credit history, which are unique to you.

While using your home equity to boost your wealth can be appealing, there are some potential risks when taking out a home equity loan. It’s important to be aware of them before making the leap, so here’s a few to be conscious of.

Additional debt

Taking out a home equity loan means you’re taking on additional debt that you’ll have to pay back. Depending on how the loan’s structured, you’ll need to be prepared to pay your current mortgage (if you have one) in addition to your equity loan repayments.

You may be paying high interest

Interest rates can be higher with home equity loans, compared to standard home loans. This means even if you’re borrowing a small amount of equity, the interest charges could really hike up your equity loan repayments and make it harder to pay back your loan.

Greater financial risk

You’re inevitably putting yourself at more financial risk when you take on another loan, because you’re taking on my debt and adding more complexity into your loan arrangements.

If you use your home equity funds to buy an investment property, for example, and the tenants fail to pay their rent, you may not be able to make your repayments and end up defaulting on your loan. This event, apart from being supremely stressful, could then lead to a lower credit score or foreclosure if you’re not able to make it work.

Similarly, if you use an equity loan to renovate your home and the renovations don’t lift the value of your property as anticipated, you could face a predicament where the loans you have over the home are worth more than the home itself (this is known as negative equity).