All Topics / The Treasure Chest / How does equity work?

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  • Profile photo of treciatrecia
    Join Date: 2003
    Post Count: 1

    Hi All, I am very new to this and I wish to learn how equity works. We are considering building a new house and after the building is constructed (perhaps 12 months down the track) having it valued again. My question is, how is the new equity used. Do you have to refinance and then pay interest on the equity you take out? Is there a way of accessing equity, without paying interest on the difference? Thanks in advance for your advice.

    Greatly Confused,

    Profile photo of Stuart WemyssStuart Wemyss
    Join Date: 2003
    Post Count: 598

    Hi Trecia

    I’ll explain how equity works by example. Say you are building your new property that costs $100,000 (including land and construction costs) financed by:

    Loan – $80,000
    Your deposit – $20,000

    Then in a year your property is worth $200,000 (that would be nice).

    What you can do is approach your bank and tell them that you want to increase your loan (this is called a loan ‘renegotiation’ or ‘variation’). They then send a valuer out to your property. If the value is $200,000 then they can increase your loan to $160,000 (being 80% of the value). You can increase to 90% but that would incur mortgage insurance (this is a one off cost – it’s expensive).

    Naturally, the bank would only increase your loan to $160,000 if you have enough income to prove that you are able to repay a loan of this size (this is called serviceability).

    You can then redraw the additional $60,000 (i.e. $160,000 less existing $100,000) and use it for what you like (e.g. property investing).

    You can also do this by shifting to a different bank (i.e. refinancing). All you have to do is apply for a loan of $160,000. When it’s approved the new bank will pay out your existing loan of $100,000 and you will have $60,000 left over.

    Let me know if this doesn’t make sense.



    Property & Finance News

    Profile photo of hwd007hwd007
    Join Date: 2002
    Post Count: 247

    I thought the Tax Office was cracking down on the use of redraw funds for anything other than the purpose the loan was intended for.

    I mean can you imagine using part of the redraw to go on a holiday, and whilst claiming the interest incurred on it as a tax deduction ?

    Profile photo of scottscott
    Join Date: 2003
    Post Count: 110

    The will be cracking down on claiming this as a deduction, as well as other aspects of IP related claims.
    This borrowed money is tax free, because it is borrowings not income, but interest payable on that portion of your loan is
    This method is usfull use when things are tight and an IP is seeing high capital growth. It should not be done lightly though as it can be dangerous if taken too far.

    Scott S

    “Aim for the stars and you’ll shoot the top of the telegraph pole. Aim for the top of the telegraph pole and you’ll shoot yourself in the foot!”

    Profile photo of treciatrecia
    Join Date: 2003
    Post Count: 1

    Thanks so much to those that replied. This has made things a lot clearer. Cheers! Trecia

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