How does home equity work in Australia

Equity is value minus debt

Start with the plain version. Say your home would sell for $800,000 today and your loan balance is $500,000. Your equity is $300,000. That is the whole formula: value minus debt.

Two things move that number. Repayments shrink the debt, slowly at first because early repayments are mostly interest. Prices move the value, and they move both ways. A soft market eats equity just as surely as a boom builds it.

One caution on the value side. The number that counts is not your guess, and not what a nearby house fetched at auction. When you apply to borrow against equity, the lender orders its own valuation, and bank valuations tend to be conservative. Plenty of applications stall right there.

Usable equity is smaller than total equity

Lenders will not let you borrow against every dollar of it. The standard rule is that total lending against a property is capped at 80 per cent of its value. Past that point, lenders mortgage insurance usually applies, at your cost. So usable equity is 80 per cent of the value, minus what you owe.

Run that on the same house, as an illustrative example. Eighty per cent of $800,000 is $640,000. Take away the $500,000 loan and you get $140,000 of usable equity. The owner has $300,000 of equity but can normally borrow less than half of it. That gap between total and usable surprises people, and it is the first number to check before making any plans.

Drawing on equity means new borrowing

There is no account somewhere holding your equity. Every way of drawing on it is new borrowing secured against your home, whatever the product is called.

• A loan increase, or top up. Your existing loan grows by the amount you draw. One loan and one repayment, though the new money blends into the old, which makes the interest hard to split for tax if the money went into an investment.
• A split loan. The new borrowing sits as a separate account against the same property. Tidier, and much easier at tax time if the drawn funds buy an investment.
• A line of credit. A facility with a set limit that you draw on as needed, paying interest only on what you use. Flexible, but usually priced above a standard variable loan.

Whichever structure you choose, the lender treats it as a fresh application. It checks income, expenses and credit history, and you must be able to service the higher repayments. Equity is the security, not the approval.

The repayments are real. Borrow the $140,000 from the example at 6.00 per cent over 30 years and the standard repayment formula puts it near $839 a month, a bit over $10,000 a year, on top of the repayments on the original loan. The rate is an assumption, so treat the figure as illustrative, but the shape of it holds at any rate you plug in.

The second property sums

The most common reason people look into equity is a second property, an investment or a holiday place. The usual structure has two standalone loans. The first draws on your current home for the deposit and purchase costs. The second sits against the new property for the rest, usually up to 80 per cent of its price.

Keep the example going, still illustrative. Usable equity is $140,000. To avoid lenders mortgage insurance on the new property you want a 20 per cent deposit, plus roughly 5 per cent for stamp duty and costs, so call it 25 per cent of the price in ready funds. $140,000 is 25 per cent of $560,000. That is about the purchase this equity supports: a $560,000 property, funded by a $140,000 draw on the home and a $448,000 loan on the new place.

Now add it up. The household owes $500,000 plus $140,000 plus $448,000, which is $1,088,000 across two properties. Rent helps, and lenders count part of it when they assess you, but every dollar of that debt is yours. Equity covered the entry costs. The repayments on all of it come out of income.

Cross collateralisation, and why standalone is cleaner

There is another way to structure the same purchase: one loan, with both properties as security. That is cross collateralisation, and lenders sometimes suggest it because it is simple to set up and keeps all the business in house.

It causes trouble later. Sell one property and the lender can hold back sale proceeds to protect its position over the other. Refinancing means moving both loans at once, so you cannot shop them separately. A weak valuation on either property can stall decisions on both. Standalone loans, one against each property with its own limit, keep each asset its own decision. Ask for that structure by name, because the crossed version is often the default offer.

What equity is not

Equity is not income. It pays no bills. Until you sell or borrow against it, it is a paper number, and borrowing turns it into debt with interest due every month.

It is not a reason to borrow, either. The sales pitch says you have $140,000 sitting there doing nothing. The equity is already doing two jobs: it is your buffer if prices fall, and it is your stake in your own home. Drawing it down for a car or a holiday trades a purchase that fades for interest that can run 30 years. Drawing it down to invest can make sense, but the investment has to work on its own numbers, not because the equity happened to be there.

Seek Mortgages is an independent publication. We do not sell loans, take enquiries or give personal advice. Whether an equity release suits you depends on your income and on what you want the money to do. Weighing that up is work for a licensed broker or adviser, not a general guide.

Where to read next

If the file behind your application is strong, the pricing side is covered in our guide to prime home loans. If the second property would be a shop or office rather than a house, commercial property loans work differently. And if you are weighing up property inside super, SMSF home loans have their own rules.

Common questions