Embarking on a home renovation journey is a thrilling endeavour, offering the promise of an improved living space and increased property value. Yet, the financial hurdles can be daunting, especially for homeowners in Australia with limited savings earmarked for such transformations.
But there is a solution that allows you to complete your home renovation without dipping into savings. Tapping into home equity is an increasingly popular method to finance renovations.
Understanding Home Equity
Home equity is the tangible difference between your property’s current market value and the outstanding balance on your mortgage—a slice of your property that you genuinely own.
This equity can grow organically, influenced by factors like value-boosting renovations and shifts in the property market, allowing you to leverage it without necessarily reducing your mortgage debt.
Calculating Your Equity
The calculation is straightforward: deduct your outstanding home loan balance from the current property value.
For instance, if your property is valued at one million dollars, your mortgage stands at $500,000, so your equity is $500,000, representing 50% ownership.
Calculating Your Usable Equity
Unfortunately, you can’t tap into your entire equity amount. Instead, your usable equity is calculated by subtracting 80% of your property’s value from the existing mortgage.
For example, if your home is valued at $1,000,000 and you currently owe $500,000 on the mortgage, your usable equity would be $300,000.
Accessing Home Equity
Refinancing your home loan is the gateway to accessing your home equity, going beyond mere interest rate adjustments. This process involves cash-out loans or line of credit loans.
1. Cash Out Loan
A home equity loan, colloquially known as a cash-out loan, permits homeowners to tap into their property’s accrued equity. This option may be more accessible compared to a line of credit loan since your property serves as collateral.
2. Line of Credit Loan
Homeowners may access equity through a line of credit, akin to a credit card with a predefined limit. While a popular choice, it’s crucial to gauge whether the available equity aligns with your renovation ambitions.
Potential Risks of Accessing Equity
While the prospect of accessing home equity is enticing, potential downsides and risks demand careful consideration:
1. Financial Stress
Increased mortgage obligations may lead to ‘mortgage stress,’ necessitating a thorough financial reassessment and potential risk of home loss if repayments become untenable.
2. Creating Bad Habits
The availability of surplus funds might tempt homeowners into non-essential spending, particularly those with suboptimal money management skills.
3. Increased Loan to Value Ratio (LVR)
Equity withdrawal elevates the mortgage amount, potentially triggering Lenders Mortgage Insurance (LMI) for borrowings exceeding 90% LVR.
Accessing home equity may incur break costs, valuation fees, legal fees, and possibly higher interest rates, impacting the overall renovation cost.
Alternative Ways to Finance Your Renovation
While home equity is a viable option, consider these alternatives:
1. Construction Loan: Ideal for substantial projects with structural changes.
2. Personal Loan or Credit Card: Suitable for covering specific renovation costs, though with higher interest rates.
3. Redraw Facility: If you’ve made extra repayments, leverage a redraw facility to fund renovations.
4. Build Your Savings: A slower but debt-free approach that encourages sound financial habits.
5. DIY: For smaller projects, a do-it-yourself approach maximises your budget.
Unlocking home equity for renovations is a strategic financial manoeuvre, but a balanced evaluation of benefits and risks is crucial.
Whether opting for equity tapping or exploring alternative funding methods, meticulous planning and financial prudence will bring your dream home within reach.
* This blog is intended for general informational purposes only. For personalised advice tailored to your unique financial situation, please contact NMC Finance.