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Equity can be used to finance property and other assets. You build equity with extra mortgage repayments & capital growth. Read on to find out how you can use the equity in your property to build wealth.
Some first home buyers want to turn their property into more wealth, which they do by growing their equity: that is, the part of the property’s value that is not owed to their lender.
There are two kinds of equity to think about: the equity the lender requires you to have in your property when you set up the loan (eg. 20% of its value), and the extra equity above that. When your extra equity is significant enough, you can use it to finance additional investments.
Home owners can only access this extra equity by increasing their mortgage or refinancing it to another lender. Your equity usually grows as a result of two circumstances: accelerated loan repayments and capital growth. Properties in major cities might be expected to produce capital growth of around 5 per cent per year, when you average it over a decade, which means your property could appreciate over time, increasing your equity. You can accelerate the growth of equity by paying down your loan principal faster than the lender’s schedule. When you have a Principal & Interest loan (P&I) your monthly repayments are large enough to cover the interest accruing and also pay down the principal amount over 25 years.
As you pay down the capital amount of the loan, you increase your equity, but you can only do this faster when you slow the interest capitalising in the loan.
Mathematically the only way to do this is to pay extra into your mortgage, whether it’s a regular extra amount on your monthly repayment, one off additional repayments as your budget allows, or switching to a fortnightly/weekly repayment strategy.
With extra repayments, an extra $500 per month in repayments in a variable rate loan can produce results very quickly because you are slowing the rate that the interest works against you.
Now look at the frequency of the repayments: if you move from monthly to fortnightly repayments you make more repayments in the year: 26 half payments rather than 12 full. By simply moving to fortnightly repayments in a $400,000, 25-year loan at 5 per cent, you pay-out the loan faster by three years and six months and save around $49,000 in interest paid. This works for weekly payments also.
If you now put tax refunds and work bonuses into the mortgage account, you further reduce interest and accelerate your equity.
Increasing equity in your property, and using it to fund more assets, is a proven way to build wealth. The question of how you access it – refinancing, redraw or line of credit – will vary according to personal circumstances. An expert such as a mortgage broker can assist in strategy and product selection