Refinancing has its benefits. If you have had your mortgage for a while, one of the main advantages of refinancing is that you can refinance to release equity.
In this article, we’ll be looking at:
- What equity is and how to grow it
- How your equity can be turned into borrowed and spendable cash
- How to find out your eligibility for refinancing
- The things you can use this equity for
- The application process
- How to decide whether releasing equity is right for you
What is equity and how do I get it?
Equity refers to the difference between the value of your home and the amount you owe on your mortgage or existing loan. The equity in your home usually increases the longer you’ve had your property, the more you’ve paid off of your mortgage, and when renovations have been made. If you have held your property for a substantial amount of time, you could be eligible to refinance and release this borrowed equity as spendable cash.
Releasing equity is like cashing out from your home loan…
If you’re planning to release equity, your lender will get your property valued. Valuations can differ depending on who conducts them, but the higher the value, the better. Why? Because it’ll increase the amount you can borrow for refinancing.
Lenders use your property value to determine your total available equity and then calculate this to determine your Loan to Value Ratio (LVR). This allows them to calculate how much you can borrow (usually up to 80% of your property value) from your home.
Since equity reduces the lender’s financial risk, a general rule of thumb is that the more equity you have, the more security for the lender. If your refinancing application and your purpose for refinancing is approved, your equity will be released into your account with the lender.
Refinancing to release equity:
Refinancing to release equity via a home equity loan or a home equity line of credit both involve essentially taking out a second mortgage. Like a regular loan, with a home equity loan, you’ll receive a one-time lump sum loan that requires monthly principal and interest repayments.
A line of credit loan on the other hand allows you to use equity as required for a certain amount of time and up to a certain amount. While monthly repayments are made on the line of credit loan, interest is only charged on the withdrawn funds.
Am I eligible for an equity release?
To be eligible to refinance and release equity there are certain requirements that must be met. These include requirements such as:
- Having a good credit rating;
- Holding your mortgage for at least six months; and,
- Providing your lender with a reason for your equity release and proof that these funds were used for what you stated.
In addition to these, you should also understand the loan options and interest rates available and have at least 20% equity in your home. While applying with less is possible, it can mean you’ll be required to pay Lender’s Mortgage Insurance (LMI).
What can I use this borrowed equity for?
Prior to your loan application being approved your lender will usually ask you what you plan to use your refinanced equity for. The answers vary depending on the individual and your future plans, however, some of the most common uses include:
- To renovate: Renovating your home with borrowed equity could be beneficial whether you just feel like revamping your home or are planning to borrow more in the future. Structural renovations like upgrading your kitchen or bathroom or installing pergolas, pools, extension stories or even granny flats add increased value to your home. This increased value adds to your total equity and can potentially increase your future borrowing capacity.
- To invest: It’s also possible to use your borrowed equity to put down a full or partial 20% deposit on an investment. This could reduce the time needed to save up a deposit, the chances of you paying (LMI) and could improve your cash flow. If you have enough equity, you could even use the extra money you borrowed to renovate your investment, thereby increasing its value and attractiveness to potential tenants.
It is also possible to invest in other areas outside of property such as in shares and stocks or various asset types.
- For Luxury: Some individuals also refinance to release equity for leisure purposes such as a big family trip or holiday. Others refinance to release equity for luxury purchases like buying a new car, that would’ve been too costly to afford without the loan.
- To start a business: Refinancing for a second loan to release equity is generally easier than applying for a business loan. You can use your equity to start up a small business but should remember that your home is essentially being used as security for the business. As always, completing your due diligence to make sure you can service the loan, keep your home and still start your business is important.
How do I apply for equity release?
Applying to refinance and release capital or equity is as simple as calling your lender or your mortgage broker and discussing your needs. The time it takes to refinance can vary depending on your situation. The quickest refinance can be completed in a week but is also dependent on the time it takes for someone to value your property.
What documentation do I need to supply?
When applying to refinance you’ll be required to provide documents such as your ID, payslips, current home loan statement and details of your expenses and assets. You may also be required to provide your lender with a reason you’re asking for an equity release and evidence of your equity use.
Evidence will vary depending on your reason for releasing capital and the loan amount you’re borrowing. For instance, if you’re buying an investment property your bank may require a copy of the contract of sale. Alternatively, if you’re renovating you may need to provide proof of building contracts or documentation you received from the contractors.
Where to go from here?
Overall, the decision to release equity is a big one. When you refinance you’ll essentially be paying for a larger portion of interest at the beginning of your new loan. If you’re towards the end of your current loan refinancing at the moment might not be the best idea.
Similarly, the timing of your application to refinance can also affect your property’s value and how much you’re allowed to borrow. Refinancing when the property market is steady or in a boom could be more beneficial than investing when the property market is in a downturn.
Unsure about whether or not releasing equity or topping up your loan is a good idea? Talk to one of our mortgage broker’s by scheduling a consultation here to better understand your options.
Disclaimer: The information provided is general in nature and does not constitute financial advice. Please speak to us for recommendations on your individual circumstance and requirements.