Unlocking your home equity? The experts weigh in on the risks and benefits

With three interest rate cuts and a strong possibility of more to come, many mortgage holders are unlocking the equity in their home loan to fund much longed-for renovations, a car, or an investment purchase.

The amount of equity – the difference between the value of your home and the amount remaining on your mortgage – is something that University of Adelaide master of property Peter Koulizos says many do not realise how much they have amassed.

“Many people don’t realise the equity they have in their home,” he says. “It’s like a sleeping giant that can slingshot you into a comfortable retirement.

“The equity is sitting there doing the thing where you can put it to work and work for you and your family.”

While using equity can be tempting, Mr Koulizos cautions against various uses.

“If you want to borrow against your house, it should be to buy an appreciating asset, whether that is investing in property or investing in shares,” he says.  

Using your equity

Perth-based Mortgage Choice broker Mila Cross explains using your equity is essentially taking tangible cash out of your home loan and increasing the current limit to access much needed funds.

 “Customers can tap into their equity to provide some needed funds for a significant home renovation, debt consolidations… buying a car, going on a holiday, those kinds of things,” she says.

“But just because you can, doesn’t always mean that you should.

“In regard to putting tangible items like a car on top of it (your mortgage) you’re going to be paying interest on that portion over the debt for a longer timeframe.

 “So I always tell my customers, they should be mindful if you are refinancing a car, (it) decreases in value, and you’re putting that extra money onto your home loan, and you need to be mindful that if you make the bare minimum of payments, it’s going to take you 30 years to pay off that car.

“You’re going to be paying a lot extra than what you would be if you just got a higher rate and had that car loan by itself.”

How it works

Ms Cross provided the following example as to how a mortgage holder – let’s call her Jane – could take out funds for renovations.

The current value on Jane’s property is $971,000 and she wants to take out $200,000 to fix her roof and fund other renovations, potentially a new kitchen.

Withdrawing the money will take Jane’s loan-to-value ratio to 61%.

“Her current rate is quite high, so she’s currently with another lender, and her rate is at 7% and we are going to be able to decrease their rate a lot and still be able to do those home renovations and still be able to pay off their property,” Ms Cross explains.

The risks to consider

While using equity can be a helpful tool for some, like anything it comes with risks, Ms Cross warns.

“Property values could decrease, so then the customer is over capitalising,” she says.

“At the moment, prices are showing that homes are valued at a lot more, but we don’t know if they’re going to come down, or what they’re going to actually do.

“Customers really need to be front of mind in regard to that aspect.”

The median price of a home in Australia is now at a record-high $827,000 after 4.9% growth in the national market over the 12 months to July, according to PropTrack data.

It is also worth considering that accessing equity also equals increased debt. Ms Cross says it is important for homeowners to really consider whether they can afford it.

“At the moment, you might only owe $300,000. Do you really want to increase to $500,000?” she says.

While Australia does not look set for any cash rate rises in the near future, Ms Cross says it is vital people consider the risks of taking out equity properly.

Being able to afford those higher repayments if interest rates increase again is a crucial consideration.

Understanding the property market cycle

Mr Koulizos says the ups and downs of the property cycle needed to be kept in mind if using equity to buy an investment property.

 “It’s not all upside in property investment,” he notes. “There are downsides… property prices can come down, you will have tenants and not everything goes perfectly with the tenants all the time, but you have to understand the risks.

“But generally speaking, if you allow time to take its course, the admiral of investing in property far outweigh the disadvantage.”

AMP head of investment strategy and chief economist Shane Oliver warned while using home equity is simpler than taking out a new loan for an investment purchase, the downside is the family home is on the hook.

What lies ahead?

With two interest rate cuts so far this year, there is indication that more mortgage holders are tapping into their equity, Mr Oliver says.

“I think we are already seeing early signs of that, arbitrary clearance rates have gone up to above average levels for this time of year,” he says.

“That’s partly reflecting increased confidence on the part of buyers citing lower interest rates, ( and house) prices are now up five months in a row.”

The Reserve Bank of Australia will make its next decision on the cash rate in late September. 

This article first appeared on Mortgage Choice and has been republished with permission.

The post Unlocking your home equity? The experts weigh in on the risks and benefits appeared first on realestate.com.au.