Unlocking your Home Equity

Are you a member of the Equity Rich, Cash Poor Club? Discover how you can use your real estate property to free up money. By Senlitonga for the March edition of the API Magazine Australia where you will find useful information about real estate investing and tips to success.

What are our options for unlocking home equity?

Question: We own our home and are looking to unlock the equity in the cheapest way, in terms of interest rates, application and ongoing fees. The home is worth $350,000 and we would need about $100,000 in the short term. What would you recommend?

Answer: You have a few options to release the equity in your real estate property. First up, although you’ve paid off the property, check that the title has been released by your previous lender. This will decrease the fee you pay when you register the title with another bank lender. One option worth considering is a revolving line of credit. If you’re familiar with this loan type, it can be basically described as an overdraft account which is secured against your home property.

The word “revolving” means there’s no contribution required to your principal, as there’s no set term. You do, however, need to cover interest expenses. Some bank lenders allow interest to be capitalised into the bank loan. This means no repayments are required if you’re still under the borrowing limit. Another option in your case is choosing a “normal” mortgage, whether basic variable, standard variable or fixed interest. This avenue is likely to cost more since most of these loans enforce an “early repayment penalty” for the first three years.

Offset Explained in Real Estate Investing

Question: What’s the difference between a transaction account which reduces interest and an offset account?

Answer: In a nutshell, most offset accounts are transaction accounts but not all transaction accounts are offset accounts. Clear as mud? To get it into perspective, you need to understand the way an offset account works. It’s a way of shrinking your home loan by linking with your transaction account, the idea that every dollar in your transaction account is offset against your home loan. There are two types of offset accounts: 100 per cent offset and partial offset.

A 100 per cent offset account will reduce the full interest charged on the home loan by the amount you have in your transaction account. For example, if you have a $250,000 loan and you have $10,000 in your transaction account, you’ll only pay interest on $240,000.

Partial offset, on the other hand, means you receive a fixed amount of interest abased on your balance in this account. For Example, you might receive 5 per cent interest on a $10,000 you have in the account. That interest then goes straight into your home loan debt without incurring the income tax owed on the interest which would happen if the money was in the normal savings account.

Obviously an ordinary transaction account that isn’t linked to your home real estate loan is of no benefit in reducing that loan but the costs versus the benefits of a standard home loan, 100 per cent offset loan and partial offset loan have to be weighed up before making a decision.

A pitfall CANNEX has identified is the ineffective use many people make of offset accounts. To generate net benefits with a loan of $250,000, borrowers need to maintain a savings account balance of $12,000. This is to compensate for the 0.6 per cent extra an offset loan will cost compared to a loan without offset facility. Of 6000 offset accounts CANNEX surveyed, 63 per cent had a balance of $5,000 or less. These borrowers for real estate aren’t making the expected inroads into their loans and may have been better off in the long run with a standard mortgage.