What is equity and how does it work?

31 Jan 2020

Let’s talk money.

While most of us have heard the word “equity”, it’s a safe bet that not everyone understands exactly what it means.

But it’s a word everyone should very quickly get acquainted with because it can be a secret weapon if used correctly.

 

What is equity?

Defined simply, equity is the positive difference between what you own and what you owe.

It’s a valuable financial resource you might not even know you have until you do your sums.

Say the market value of your home is $700,000 and there is $300,000 remaining on your home loan – the $400,000 difference is the equity you have in your home.

Although it doesn’t look like cash in your hands, it is valued by lenders just as highly.

BCP Finance director Brett Hartwig says everyone is trying to generate equity and build up their wealth.

“Equity growth is a cycle that starts very early in someone’s life, the principals don’t change,” he says.

“Even as a young child buying your first bike, you are saving money and investing in something for a purpose.”

 

How can I grow my home equity?

Once your home begins growing in value, your equity does too.

The current market value of your home against the amount you have left to pay the lender can build up over time, depending on the property type, location and overall condition.

Properly servicing your loan is key to building home equity, according to Mr Hartwig.

“Your repayments will drive that gap between the proportion of your home that you own and what you still owe,” he says.

“Cash contributions and special repayments on top of your regular mortgage repayments will see you generate equity faster.”

Minor facelifts or major renovations can also work to bump up the value of your home, however Mr Hartwig warns against overcapitalising.

“People can overextend themselves financially with their servicing capacity by taking on too much debt and not have this reflected in the increased value of their residence,” he says.

 

What can I do with my home equity?

Leveraging equity in an existing property to develop an investment portfolio is one of the most common uses of home equity, Mr Hartwig says.

“Home equity is generally tapped into by home owners buying their second or third property, people who are trying to generate wealth,” he says.

“There’s an overriding view the Australian housing market will have growth in it and that investment properties will generate solid returns for the owners.”

Home equity is an asset so banks and other lenders will allow you to borrow against the equity you have in your property to finance spending on things such as renovations or extensions, holidays or a new car.

“Anyone leveraging off their existing home needs to be well informed and it needs to fit in with an overall financial plan,” Mr Hartwig recommends.

“It’s all about how you access your equity and how you make it work for you.

“The best thing is to continue to make your equity grow and not let it diminish.”


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