The word ‘equity’ is used in a lot of conversations about investment. But what does it mean? And how can you get more of it?
Put simply, equity is the difference between what your property is worth, and what you still owe on it. The best part about investing in property or owning a home in Australia is that the value will most likely continue to increase for as long as you have it. As this value continues to increase, your equity will increase, and you will be able to use that equity to buy more property or for other reasons such as renovating or buying a new car.
There is equity, and there is ‘usable equity’, which is the sum that the bank will let you take out to use. To work out how much usable equity you have, you will need an official evaluation of your house or property by the bank. Once you know what the current value of the property is, they will work out the equity and the usable equity.
An example of how this process might work is this; let’s say you bought a property a few years ago for $500,000. The property has now been valued at $800,000 in the current market. You still owe $200,000 on the mortgage.
The equity in your home is: $800,000 (current value) – $200,000 (what you still owe) = $600,000 in equity.
Finding the usable equity will require an assessment by the bank that you are going through. But a general rule of thumb is that they will work it out as 80% of the value of the property, minus what you still owe. Using the example above it will be $640,000 (80% of $800k) – $200,000 (that you still owe) = $440,000 in usable equity. There are plenty of online calculators that can help you work out your usable equity. The reason the bank will choose to give you a percentage of the value of the home instead of the full amount, is because they need to leave a buffer in case the market changes and the value of the home falls.
You can use this equity for whatever you like, whether it is to continue growing your investments or to do something nice like take a holiday. However, this isn’t free and easy money and there are some things to consider before going down this path.
First, you need to tell your lender what you are planning on doing with the money, and they will decide whether to release the funds (and how much) based on that.
Second, it is worth remembering that using equity is the same as getting a loan, and it all needs to be repaid eventually. You need to work out what you can afford to pay back each month and if it is worth taking the money out to use.
The only way you can access equity without it being a loan is to sell the property.
How to increase your equity
A rising local market will increase the equity in your property without you having to lift a finger. Other ways to increase equity is by paying down the principal loan or by carrying out improvements on the property.
Any improvement you make will increase the value of the home, but not all improvements are made equal. There are some upgrades you can do to a property that will increase the value more than others.
The first step you should take before making any improvements is to talk to a friendly real estate agent. A local estate agent knows what people are looking for in a house specifically in your area, so they know what is going to be in demand and what will drive the value higher.
However, there are some things you can do to improve the home that will increase the value no matter where you live.
Add Rooms
Additional rooms will always add value to a property. This can be done by extending the home to include new rooms, or it can be done by dividing existing large rooms with a gyprock wall. The new rooms don’t have to always be bedrooms. A home office or a second living area also add value and are usually highly sought-after spaces. A second bathroom or an ensuite are also very popular.
Build a Granny Flat
If you have the space, building a granny flat on your property is a sure-fire way to increase the value of your home. This second dwelling can be in high demand from people who have teenagers, extended family living with them, or from people who want the stream of income it can provide from renting it out. You’ll need council permits before you start building, but it’s usually well worth the time and effort required.
Improvements
As mentioned above, any improvements you make will increase the value of your property. Renovating the kitchen or bathroom will add a lot of value, but even a coat of paint and some DIY landscaping will help. If you own the property for many years there are a lot of small improvements you can make over that time, that will all add up to a lot of extra equity in your home. If the property is an investment that you are renting out, these improvements will also increase the amount of rent you can charge, meaning you get more from your investment in the hand now as well as in the equity later.