Common Mistakes Calculating Home Equity for a Refinance

Your usable equity is lower than the gap between your home's value and your loan. Lenders cap how much they will lend against a property, so the number you work out on the back of an envelope is rarely the number you can access. Singleton homeowners who get this right before they refinance save themselves a knockback and a wasted application.

How Do You Calculate Home Equity?

Home equity is your property's current value minus what you owe on it. Usable equity is the portion a lender will let you borrow, which is usually the value up to a set loan-to-valuation ratio (LVR) minus your loan balance.

Many lenders stop at 80% of the value before they charge lenders mortgage insurance (LMI). Moneysmart notes that borrowers with less than 20% equity might have to pay LMI, which can add to the cost of switching. So the calculation is: value x 80%, minus your current loan balance. What is left is your usable equity, depending on the lender and your circumstances.

Mistake One: Using the Wrong Property Value

The value that counts is the lender's valuation, not your own estimate or what a neighbour's house sold for. A valuation that lands below your expectation shrinks your usable equity straight away, because the 80% limit applies to the lower figure.

A small drop in value hits harder than it looks. If your value falls by 5%, your usable equity falls by 4% of the original value, because the lender only counts 80% of it. Treat your own estimate as a starting point only. We can give you an estimate of your property valuation, but the lender's valuation, usually ordered after you apply, is the figure that counts.

Mistake Two: Ignoring the Costs of Getting Out of Your Current Loan

Switching costs reduce the benefit of any equity you release. Moneysmart lists a break fee on a fixed rate loan, a discharge or termination fee, an application fee on the new loan, and possibly LMI.

A break fee only applies if you end a fixed rate loan before the fixed term finishes. If your fixed rate period is ending soon, waiting can remove that cost altogether. Read more on fixed rate expiry before you lodge anything. Note that exit fees on variable loans secured over residential property taken out on or after 1 July 2011 are generally prohibited, but a discharge fee can still apply.

Equity Release Example: Borrowing for a Renovation

Consider a Singleton homeowner whose fixed rate has just expired and who has slipped onto a higher variable rate. Their loan balance is 60% of the property's valuation, and they want $50,000 for renovations.

The maths, assuming the home is valued at $700,000: 80% is $560,000. Less a $420,000 balance (60%), usable equity is $140,000, so the $50,000 fits. The $50,000 would only fit if the valuation is at least $250,000. Whether LMI applies depends on the lender's valuation, policy and credit assessment. At the illustrative rate of 6.75% p.a., the extra $50,000 adds about $345 a month if repaid over 25 years with principal and interest. On an interest-only basis at the same rate it would add about $281 a month, but the debt would not shrink.

The outcome: the owner moves to a lower interest rate on the whole loan, funds the renovation, and sees the added repayment before signing. The trade-off is that they now owe more, and extra borrowing spread over a long term means paying more interest in total. You can test your own numbers with our mortgage repayment calculator.

Does Releasing Equity Change Your Tax Position?

Yes, it can. What you use the money for determines whether the interest is deductible, not the property that secures the loan.

The ATO says interest is not deductible on borrowings used for private purposes, even if a rental property is the security. A renovation on the home you live in is a private use. If part of a refinanced loan funds an investment, that part is treated separately and the interest must be apportioned. Keep clear records of what each amount was used for and speak to your accountant before you act. If you are planning to use equity for a rental purchase, our investment loans page explains the options.

Why Lenders May Say No Even When Your Equity Looks Strong

Equity is only one part of the assessment. A lender must also check that you can afford the repayments and that the loan meets your requirements.

APRA requires banks to test new borrowers' ability to meet repayments at an interest rate at least 3 percentage points above the loan rate. A refinance that increases your debt is assessed on that basis, so income and other debts matter as much as the value of your home. Your repayment history is also considered. This is why a loan health check before you apply is worthwhile: it shows where you stand on both equity and serviceability.

Is Refinancing Worth It for Your Situation?

Refinancing is worth it when the overall saving outweighs the costs and any benefits you lose. ASIC guidance says a broker must consider whether the new loan produces cost savings that outweigh lost features, taking into account all fees, including broker fees.

That means the answer is sometimes to stay put. If the saving is small and the costs are high, we will tell you directly. If you hold a loan under the Australian Government 5% Deposit Scheme, moving to a lender outside the scheme means losing its benefit, and increasing the loan is not permitted under the scheme. Check this first.

If you are in Singleton and want your equity worked out properly, our Singleton mortgage broker team will run the numbers with you. Call one of our team or book an appointment at a time that works for you.

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