What is a home equity loan?

Home equity is the difference between what you owe on your mortgage and what your property is worth or its value. It's a part of your property or house that is yours, which can be used as security to borrow money through a home equity loan or simply an equity loan.

An equity loan is a general term used to describe any type of loan that allows homeowners to borrow against the equity of their properties. The amount of loan is determined by the equity value.

The basic types of a home equity loan are the following:

• Lump-sum. In this type, you borrow an approved amount or a lump sum, and make necessary repayments (with interest) over time.
• Line of credit. In a line of credit, you are allowed to borrow a smaller amount up to a predefined limit. When a need arises, you can reborrow, considering that you're not exceeding the maximum limit of your equity that's available.
• Reverse home loan. This type is less common and usually appropriate for retirees who own properties. A reverse home loan allows them to release property equity to a lender in exchange for a lump sum, a line of credit or regular payments. No monthly repayments are required in this type of equity loan, but the lenders charge interest, which must be repaid in full when the borrower sells the property, moves to aged care or passes away.
  

How does a home equity loan work?

A home equity loan is a second mortgage in which your home equity is collateral accepted by lenders as security for a loan. Similar to other mortgages, this loan has a set repayment term. You, as a borrower, regularly pay for a fixed payment that includes both the principal and interests. When you default, your home could be liquidated to cover the remaining debt.

How much equity can you borrow?

Different lenders may have varying policies with regard to the amount that they can lend. Many of them may be prepared to give up to 80%-90% of the home's loan-to-value ratio (LVR). The LVR is the loan amount expressed as a percentage of the market value of the home. Other lenders may give higher amounts but will ask you to secure their mortgage insurance to protect them from possible defaults on repayments. 

Where can you use your equity loan?

A home equity loan can be used in a number of ways:

• Home renovations. If you want to increase the value of your home or property, you can use your equity loan to achieve this. When done, your property can be more suitable for your needs or its resale value in the future is maximised.
• Investments. An equity loan can be a means to grow your wealth and build your retirement portfolio. You can use it to buy shares or bonds, invest in a new business or as a deposit for a new property.
• Debt consolidation. Paying off a high-interest debt by consolidating them into a single large repayment will help you save on interest rates. An equity loan can be used for this purpose. 
• Lifestyle affordability. Whether it's a new car, your child's education or a dream vacation, your equity loan can fund these personal expenses.
  

How can you build equity in your home?

To access greater funding from your equity, it must be built up. Below are two of the most common ways to build equity in your home.

• Add value to your home. Renovation increases your property value. As a result, your equity also increases. You may add another room, replace the bathroom or buy new fixtures. All of these can even be done by using a home equity loan.
• Pay off your mortgage. Equity is computed using the current value of your home. If house prices continue to rise in your area, your home may be more valuable than it was when you first pay off your mortgage. And when you have kept up with your repayments, which reduces the amount you owe the bank or your lender, you probably have higher equity. Equity increases each time you repay your lender. You can also make the amount accumulate faster by paying extra onto the home loan principal.
  

What are the advantages of an equity loan?

Similar to other loans, a home equity loan can be either good or bad for you, depending on the way you will use your money or your financial circumstances. Among the advantages of this loan are as follows:

• Access to extra funding. With the simple application process, taking out a home equity loan is an easy way to gain funds without selling your property. Its rates are also generally lower because of the high security your property provides to a lender.
• Increasing property value. The funds can be used for various purposes, including home renovation. When you use the money to improve your home, you are increasing your property value. You can even add wealth by investing in other properties or buying shares.