FACT: Equity isn’t free money
In the last few months and years, I have had many of my clients and many enquiries about Equity. There seems to be a misunderstanding on what it is and how it works? So, I am going to explain briefly what equity is and how it works.
What is Equity?
Equity is the difference between the current value of your prized asset less the mortgage you owe to the bank on the prized asset itself.
Here's a small and basic example:
You bought a house for $600,000.00 and paid a 20% deposit. The loan amount is $480,000.00 to start with. It’s been a couple of years and market is going well and now your house value according to the current market is gone up to $700,000.00. And as you're paying your home loan, the loan amount has gone down to $450,000.00.
In this case, $700,000.00 less $450,000.00 has a total equity is $250,000.00.
I want to point out one important thing before I explain how it works. Equity is a loan unless you sell the house and then it’s capital gains either on owner occupied or investment. At the end of the day the point it's not your money if you don’t sell the asset.
So, if equity isn’t free money, how does it work?
By taking the above scenario in place, I get asked the following questions:
How much can I borrow out of Equity?
If its not my money, why would I get interest charged on it?
Does my borrowing power get affected if I use my equity?
Now let’s answer them one by one:
How much can I borrow out of Equity?
In the above scenario, I can borrow 90% of the value of the property. Which would be $700,000.00 into 90% which is $630,000.00 less any Loan Mortgage Insurance (LMI If you want to enter this territory). That would mean I would get $630,000.00 less $450,000.00 that is $180,000.00 less any mortgage insurance applicable. If you want to save the Loan Mortgage Insurance, you will have to access equity only up to 80% of the value of the asset.
If its not my money, why would I get interest charged on it?
Unless you sell your prized asset, you would be accessing the equity from the bank. Bad news is they don't do anything for free, especially lending money. The business of lending money has costs involved - we call it interest. You would be borrowing the equity again which is type of loan and the fancy word for it is ✨Equity✨.
Does my borrowing power get affected if I use my equity?
The simple answer to this is question is yes, like any other credit facility like car loans, credit card etc, equity is also a loan and would directly affect your borrowing capacity by lowering it.
I hope the above makes it easy to understand, but if you have still unanswered questions, we here at Wyn Finance are here to help.
-Angad
