The equity you have in your home is simply the difference between the current market value of your home and the amount you still owe on your home loan. For example, if your home is worth $800,000 and your outstanding loan balance is $200,000, your equity is $600,000.
Your equity increases as home loan repayments reduce your loan balance or whenever your property increases in value. While you can’t control the property market, the more that you can pay off your home loan the quicker you build equity.
Many people are content to sit on this growing equity. However, it’s possible to utilise even modest amounts of equity to boost the rate at which you can build additional wealth. And you don’t need to pay off your entire mortgage to do so.
Putting equity to work
Putting your equity to work involves borrowing against your increased share of the value of your home and investing the proceeds. This could be by:
- Buying an investment property.
- Investing in shares or other growth assets.
- Renovating your home, provided the increase in home value exceeds the cost of renovations.
The key requirement for boosting wealth by using equity is that the long-term returns from your selected investments (capital growth, rent, dividends or distributions) need to exceed the long-term costs (interest payments, insurance, repairs and maintenance, taxes and management costs).
The emphasis here is on ‘long-term’. In the short term property and share prices can fluctuate. If your investments fall in value, so does your equity. Taking on too much debt, even to fund productive assets, can lead to real financial stress. Interest rate rises may increase your loan servicing costs. It’s therefore important to introduce buffers such as not borrowing too much and factoring in possible interest rate rises to ensure that your strategy can survive the ups and downs of the various markets.
Also bear in mind that the out of pocket costs of funding an investment may be higher in the early years. Over time, however, increasing rent or dividend income help to cover costs.
It may be tempting to use some of your equity in your home to fund lifestyle, such as a holiday or new car. And if it adds to your enjoyment of life, why not? Just be aware that funding living expenses with debt tends to erode wealth rather than build it.
Be informed
Using the equity in your home to help you build your wealth is just one form of borrowing to invest. Done well it can provide a real boost to wealth. However, as this is quite a technical area of financial planning it’s important to understand how building wealth with debt works and to appreciate the risks involved.
Your financial planner will be able to look at your specific situation and help you design a strategy that will allow you to take advantage of your equity.
And when it comes to putting that strategy into practice, a mortgage broker can help you find the loan that’s right for you.