How much equity do I need for a home loan?

Buying your first home involves paying a deposit on the property. Saving up this deposit can be a challenge, but once you have a mortgage, you can start building up equity in the property. This equity could eventually be used to refinance your home loan, access a line or credit, or even to take out a mortgage on a second property. So how much equity would you need to start building your property portfolio?

What exactly is equity?

In brief, your equity is the percentage of your home’s value that you own outright, and doesn’t have any money owing on it. You can estimate your current home equity by finding the current value of your home and subtracting the amount still owing on your mortgage.

For example, imagine you buy a unit worth $500,000 by paying a $100,000 deposit and borrowing $400,000. You’ll be starting your home loan with 20% equity in the property.

How do I increase my equity?

There are two main ways to increase your equity: mortgage payments and capital growth.

Each time you make a principal and interest mortgage repayment, you’ll be paying back a small part of your home loan. If you’re able to put more money towards your home loan principal, such as by making extra repayments or paying less interest (such as with the help of an offset account), you can build your equity in the property faster.

If your property’s value increases over time, such as if the area grows in popularity and other similar properties nearby start selling for high prices, this can also build up your equity. Of course, the reverse is also true – if property values in your area start to fall, you could find you have less equity in your property than you realise, or even end up in negative equity, where you owe more money than the property is worth.

To follow the previous example, imagine that after some time diligently making your repayments (plus extra when you can afford it), you’ve put $100,000 towards your home loan’s principal. Combined with your initial $100,000 deposit, this leaves $300,000 still owing on the mortgage, giving you 40% equity in your $500,000 property.

Now imagine that after a valuation, you find that your property is now worth $600,000, thanks to rising prices in the area. With just $300,000 owing on your mortgage, this means you now have 50% equity in your unit.

How much equity do I need to apply for another home loan?

Some homeowners use their equity in place of a deposit when applying for a loan to buy an investment property, to avoid having to save up a large sum of money again.

But it’s important to keep in mind that your lender may not allow you to use all of your equity to apply for home loans or access lines or credit. Your lender will likely want you to keep at least 20% of your equity in your property to help reduce the lender’s risk of financial loss if you were to default on your repayments – the same reason why most lenders prefer a 20% deposit, or require you to pay Lender’s Mortgage Insurance (LMI).

You can find your usable equity by subtracting the principal owing on your mortgage from 80% of your home’s current value.

To follow the previous examples, your lender will want you to keep at least 20% equity in your unit, now valued at $600,000 – in this case, $120,000, leaving $480,000 of value. Subtracting the outstanding mortgage of $300,00, this leaves you with $180,000 of usable equity to work with. This could potentially be used as a 20% deposit on a mortgage for a $900,000 property, though you’ll also need to cover stamp duty and other fees, charges and expenses – a common rule of thumb is to look at investment properties worth four times your usable equity, to account for these expenses.

You may want to check if you have enough usable equity available to make up a 20% deposit on the investment property you’re considering, as a smaller deposit may require you to pay LMI.

Some investors use strategies like this to build up portfolios of multiple investment properties, using the equity in each property to purchase the next one. However, a significant risk to this strategy is that if you default on the repayments for one property, you could end up losing all of them.

Before you start using your equity to invest, you may want to seek professional financial advice to make sure this is the best choice for your situation and to help you achieve your personal goals. A mortgage broker may be able to help you crunch the numbers, estimate your usable equity, and work out if you have enough available to apply for your next home loan.   

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