How to shop for a home equity loan

A home equity loan lets you put the value of a property to work, whether you want to renovate your home or buy another property. Understanding how to compare home equity loans and knowing what you’ll need to apply can help make your experience smoother.

How does a home equity loan work?

If you already own a home or an investment property, the value of that property minus your remaining mortgage principal is your equity. In other words, this is how much of your home you own outright, without the bank or mortgage lender holding an interest.

A home equity loan allows you to use part of your available equity as security to borrow more money, either as a lump sum to be repaid over time, similarly to a personal loan or home loan, or as a line of credit that lets you borrow and repay money up to a pre-set limit, similarly to a credit card.

How to compare home equity loans 

When looking at different potential home equity loan options, it’s important to answer a few simple questions, such as:

How much can you borrow? 

The maximum amount you can borrow in a home equity loan will be based on how much usable equity you have available. Many lenders will want you to maintain a loan to value ratio (LVR) in your property of at least 80 per cent, so your usable equity may be 80 per cent of your property’s value minus your remaining mortgage principal. Some lenders may allow a higher LVR, but you may need to pay for Lender’s Mortgage Insurance (LMI).

If you’re borrowing a lump sum to be repaid over time, similarly to a personal loan, the maximum amount you may be able to borrow may be based on your usable equity available.

If you’re accessing equity to purchase an investment property, your usable equity may function much like the deposit on your first home loan. So, if you had $100,000 in usable equity available, you could potentially use it as a 20 per cent deposit on a $400,000 loan to purchase a$500,000 investment property, though you’ll also have to budget for stamp duty and other fees, taxes and charges. Plus, if you default on your repayments, you risk losing both properties.  

If you’re applying for a line of credit, your maximum limit may be based on your available usable equity. That said, some lenders may set caps on the credit limits they’ll offer (e.g. $70,000 or $100,000), even if you have more usable equity available. Compare different options to make sure you can access enough credit to achieve your goals.

How can you use your home equity loan? 

A home equity loan may be used for a variety of different purposes, such as:

• Purchasing an investment property
• Consolidating debt
• Renovating your home
• Investing in shares
• Buying a car
• Paying for education
• Paying for a holiday
• Paying for a wedding

However, similarly to some personal loans, some lenders may not offer home equity loans for some purposes, due to the potential risk involved. You may need to provide your lender with evidence of your plans for the home equity loan, such as a letter from an account, conveyancer, or building contractor.

If you have a specific plan in mind for your home equity loan, it may be worth comparing options to see which choices may be best suited.

Consider the interest rates, fees, features and benefits 

Much like choosing a home loan, choosing a home equity loan may involve looking at what’s on offer and the terms and conditions involved, to help you get a better idea of the overall value.

Interest rates on home equity loans are often lower than those on similar personal loans and credit cards, though they may be higher than those of more typical home loans. Depending on the type of home equity loan, interest may be charged at a fixed or variable rate. Home equity lines of credit often charge interest only, based on the amount you have accessed so far, and you may be allowed to capitalise the interest charges, adding them to your line of credit until it reaches its limit.

Home equity loans may charge application fees when you first apply, and ongoing fees paid monthly or annually. You may also be charged a valuation fee.

What you’ll need to apply for a home equity loan 

1. Equity in a property: You can use a free property report to estimate the current value of your property, though a formal valuation will be required for your home equity loan application. You can build up equity by making principal and interest repayments onto a home loan (including extra repayments), or by waiting for prices in your area to rise (though this doesn’t always occur).  
2. Proof of income and expenses: Much like applying for a typical home loan, you’ll need to show the bank that you can afford the repayments on a home equity loan using payslips, bank statements, or other paperwork.
3. A valuation: This will usually be organised by the lender as part of the application process. Some lenders pass on the valuer’s fee for you to pay, though you may be able to negotiate this. Remember that the formal valuation may not match the result you get from a free property value estimate.
4. A good credit score: Even though a home equity loan is secured by the value of your equity, lenders may still want to check the potential likelihood that you could run up more debt than you can comfortably afford to repay. A free credit check can help you see yourself how a lender sees you, and allow you to correct any errors in your credit history.

If you need help finding a home equity loan, or would like more advice on if a home equity loan is the best option for your and your finances, consider contacting a mortgage broker.

Compare home loans in Australia