The property boom has seen a real jump in the net worth of many Australians as the value of their home far outstrips their mortgage balance. In industry terminology this is known as having “equity” and the rapid increase of that equity opens up many opportunities to advance your enjoyment of life and your financial position.
Home equity is a powerful thing, as this example will illustrate. Let’s say John and Catherine bought a home 10 years ago for $500,000. They purchased it with a $50,000 deposit and a mortgage of $450,000. Over the 10 years they have managed to pay back $150,000 of the principal on the loan, so they still owe $300,000. Over the same period, however, the desirability of their suburb and the improvements they have made (along with the growth in the market) has seen the value of their home climb to $900,000.
That means they now have equity of $600,000 (ie $900,000 value – $300,000 mortgage). This leap in net worth holds lots of potential for John and Catherine, but that value and financial power is locked up in their home unless they find a way to release it.
Refinancing provides the key
In an increasingly competitive mortgage marketplace, refinancing could give people such as John and Catherine the ideal way to make the most of their equity, while improving their mortgage efficiency. A loan that may have been attractive 10 years ago may now have fallen behind in its competitiveness and refinancing to a lower interest rate may well be possible.
What many people don’t realise is that the increase in their equity puts them in a stronger bargaining position. Lenders like the security of high equity and many are prepared to offer a lower rate to attract your business.
“There are a couple of benefits associated with refinancing,” says Mortgage Choice CEO John Flavell. “In the first instance, refinancing may allow a borrower to snag a more competitive home loan rate, thus reducing their regular mortgage repayments.”
“In addition, for those thinking of renovating their home or financing an investment property purchase, refinancing is a great way to achieve those goals.”
A lower rate can either free up your income though lower repayments, or you can choose to maintain the same repayment amount and accelerate the rate at which you pay back principal.
Refinancing to a new lender can also allow you to update your loan to include more flexible features, such as an offset account or redraw option, which can allow you to utilise your equity for lifestyle or investment purposes.
Look at various options available, such as consolidating debt into your mortgage at a lower rate
Using equity wisely
While having access to your home equity through a redraw facility brings opportunity to do some constructive things, it is important to ensure you use it responsibly and not simply treat it as a bottomless pit of cash. Let’s look at some options.
Consolidating bad debt
One possible use for using the cash from home equity is to pay out high interest loans, such as credit cards and personal loans, and consolidate that debt into your mortgage at a much lower rate. This can improve your overall financial position and take the stress out of your finances.
Redrawing from your mortgage can also be applied to increasing the value of your home by funding home improvements. A new kitchen or bathroom, for example, will not only improve lifestyle, but can also make your home more saleable and increase its sale price.
Flavell says that unlocking equity to renovate can be a smart decision. “Not only will renovating potentially help a home owner to improve their current living arrangements and quality of life,” he says, “but it may also help them add value to their home, which they will realise when they sell their property in due course.”
Borrowers can potentially use the equity in their home to build value in their property and/or or generate a new source of wealth and income through investing.
“If done correctly, owning an investment property can be a great way for Australians to boost their retirement savings and improve their future cash flow,” adds Flavell.
Fuelling your wealth creation
Accessing home equity can also be applied to other investment plans, such as shares or managed funds, to help build your wealth and diversify your portfolio of investments. Care needs to be taken, however, so that you do not over-commit funds from your equity into high risk investments, which may not be easily liquidated in an emergency. Getting some professional financial advice may be useful in this regard.
The equity locked up in your home holds plenty of opportunities to improve your lifestyle
Accessing equity can be used for spending on recreation and enjoyment, such as buying a boat or taking an overseas holiday. This may well suit your priorities and give you a well-earned reward, but do be careful that you don’t splurge all your equity too frivolously and leave yourself with too high a mortgage later in life.
Refinance when you downsize
For those of us approaching retirement, the concept of downsizing can hold some appeal as a way of relieving the burden of looking after a larger property and reducing mortgage principal. You can use the downsizing process as an opportunity to refinance to a more favourable interest rate to reduce repayments even further. This can allow you to free up disposable income and improve lifestyle at a time in life when you deserve to enjoy the fruits of your labour a little more.
Speaking to a mortgage broker about your refinancing potential can be a great first step to opening up a host of opportunities. Specialist advice is important, says Flavell, adding that “everybody’s financial situation is different”.
“For people wondering whether or not now is the right time to refinance, the best thing they can do is speak to their mortgage broker.”
You may be surprised at how much you can save on interest.
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