Using the equity in your current home

Learn how to unlock the value built up in your property for your next purchase.

Defining useable equity

Equity is the difference between the current market value of your property and the amount you owe the bank. However, not all equity is useable. Lenders in Australia typically allow you to borrow up to 80 percent of the property's value without paying Lenders Mortgage Insurance. The useable equity is therefore 80 percent of your home's value minus your existing mortgage. For example, if your home is worth 800,000 dollars and you owe 300,000 dollars, your total equity is 500,000 dollars. Your useable equity would be 640,000 dollars (80 percent of 800,000) minus 300,000 dollars, leaving you with 340,000 dollars to put towards a new deposit or costs.

Accessing this equity usually involves refinancing your current loan or taking out a new loan against the property. This money can be used to pay for the deposit on your next home, covering the gap before your current home sells. It is important to remember that using equity increases your total debt. You are essentially borrowing more money against your current asset to fund the new one. Lenders will perform a full credit assessment to ensure you can service the higher loan amount. They will look at your income, existing liabilities, and your history of managing your current mortgage. This process can take several weeks, so start early.

Deposit bonds and bank guarantees

If your equity is tied up and you do not have sufficient cash for a deposit, you might consider a deposit bond or a bank guarantee. A deposit bond is an insurance policy that acts as a guarantee to the seller that the 10 percent deposit will be paid at settlement. It is often used by buyers who are selling and buying simultaneously. The seller must agree to accept a bond instead of cash. While common in some parts of Australia, you must check if the Victorian vendor and their legal representative are willing to accept one. Some auction contracts specifically exclude the use of deposit bonds, so read the Section 32 statement carefully.

• Calculate 80 percent of your estimated home value
• Subtract your current mortgage balance
• Factor in Lenders Mortgage Insurance if exceeding 80 percent
• Check if your lender offers deposit bonds
• Review Section 32 for deposit requirements

Refinancing for your upgrade

Refinancing is an opportune time to review your loan structure. You might move from a basic variable loan to one with an offset account or a redraw facility. An offset account can be particularly useful for upgraders, as any cash from your sale can be parked there to reduce interest on your new, larger mortgage while remaining accessible. Be aware of exit fees or break costs if you are currently on a fixed rate loan. These costs can be substantial and may outweigh the benefits of switching lenders. Always ask for a 'key facts sheet' from potential lenders to compare the true cost of different loan products.

When using equity, you must also consider the tax implications if you plan to keep your current home as an investment property. The way you structure your loans can impact the deductibility of interest. Generally, the purpose of the loan determines tax deductibility, not the security used. If you borrow against your first home to buy a second home to live in, that interest is usually not tax deductible. Consult a qualified accountant to ensure your loan structure is optimized for your long term financial goals. Mistakes in this area can be costly and difficult to rectify once the new loans are established.

Finally, ensure you have a buffer. Property valuations are opinions, not guarantees. If a bank valuation comes in lower than your expectation, your useable equity will decrease. This could leave you short of the funds needed for your deposit or stamp duty. It is wise to have a secondary source of funds, such as personal savings or a family gift, or to aim for a purchase price slightly below your maximum borrowing capacity. This conservative approach provides a safety net against market fluctuations or unexpected valuation discrepancies during the loan application process.