Home equity loan guidelines

If you’ve been paying off your mortgage for a little while you’ll start to build up a bit of equity, particularly if the housing market in your area is seeing property values increase. You may be wondering how you could access that equity, whether to pay off a debt, fund home renovations or take your family on a holiday.

Equity – the difference between the value of your property and the loan amount – may be accessed if needed for whatever financial reason. And may be done through a home equity loan.

However, home equity loans aren’t a one-size-fits-all financing option. Let’s explore some of the basic guidelines so you can deepen your understanding of home equity loans.

All about home equity loans

What to know about home equity loans

Home equity loans are where a borrower uses the equity in their property as security to borrow money.

There are three main ways homeowners can access the equity in their home via a home equity loan:

• Line of credit – Like a credit card, you are given a pre-approved credit limit and may use these funds you need. CBA, ANZ, Westpac offer Line-of-credit-type home equity products. You pay interest on any funds you borrow.
• Lump sum – Like a personal loan, you may be able to use your equity as security to borrow a sum of money to be repaid with interest.
• Reverse mortgage – Available for retirees, typically for those who own their property outright. This option is usually used to help fund retirement costs. You may access part of the value of your property, either as ongoing income or a lump sum. This is repaid when the borrower chooses, including when selling the home, if moving into aged care of if they pass away.

Some homeowners may choose to access the equity in their mortgage by refinancing and increasing their loan value. This is different to a home equity loan but still one option homeowners may want to consider in their research.

When can you use a home equity loan?

You may be able to apply for a home equity loan when you have enough equity to use, generally when the property has increased in value and/or if you’ve paid equity into the loan over several years.

You may be wondering if you can use a home equity loan for anything, aka if the purpose of the loan matters to the bank. There are a range of reasons a borrower may want to take out a home equity loan, including to purchase a new property, for debt consolidation, for travel, for medical costs, or for home renovations to further increase the property’s equity.

A lender may not enquire into the purpose of the home equity loan compared to the strict eligibility associated with personal loans and car loans. But this may depend on the lender, so keep this in mind.

The amount of equity a homeowner can access may depend on their personal financial situation and is determined by the lender. The lender may assess your income, living expenses and liabilities to determine the pre-approved amount you may be eligible for.

The lender may also need to perform a valuation of your property to internally assess your equity levels. Property valuation may take several days, so if you’re in urgent need of funds you’ll want to keep this in mind.

How can you increase your equity?

There are a few ways that homeowners may be able to increase their equity before applying for a home equity loan. This may help to boost the amount of funds they are approved to access, whether through a line of credit or as a lump sum.

Increasing your property equity may be done through:

• Renovating and upgrading the interior and/or exterior of the property.
• Reducing the loan balance by making extra repayments.
• Using an offset account to reduce the amount of interest charged on the loan and in turn decreasing the overall loan balance.

What are the risks of a home equity loan?

There are some potential risks that homeowners may need to consider before applying for a home equity loan. While access to funds when needed, whether for renovation or a family holiday, can seem ideal, it’s important to weigh up the disadvantages too.

Firstly, by reducing your equity your home loan repayments may increase too. This is generally because you’ve withdrawn from the amount of money you’ve paid into the loan, increasing the balance owing.

Also, in terms of home equity loan terms, there is typically no set repayment term. So, unlike a personal loan that you know may be paid off in 3 years, for example, the home equity loan may be added to your loan balance and therefore repaid over your loan term. This may turn what could have been a 3-year fixed personal loan into thousands of dollars in additional interest charged on a higher mortgage balance over many more years.

Finally, if for whatever reason you find that you can no longer service these new home equity loan repayments, you may be at risk of losing the property. As with any financial product, taking on debt you cannot repay may result in defaulting on the loan. Not only may the property be seized by the bank, but this will hurt your credit history and credit score.

What are some alternatives to home equity loans?

Unsure if a home equity loan is right for you or just want to consider all your options? You may want to consider the following:

• Personal loan – While a personal loan’s interest rates may be higher on average than current home loan rates, they offer much shorter loan terms. This means that you may end up paying less interest over time on top of the funds you’re looking to access.
• Credit card – Depending on the amount of cash you’re after, it may be worth considering a low-rate or interest-free credit card as an alternative. You will only have access to what has been approved as your credit limit, but if you can pay your balance in full by the next statement period you may avoid interest charges altogether. Keep in mind that it is very easy to accrue interest on a credit card if mismanaged as the average card rate has sat around 16 per cent for many years.

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