Switching to a new home loan is called refinancing. It's a good way to get a lower interest rate or a home loan that just works better for you. But it you don't have enough equity then refinancing is going to be quite expensive, or even impossible.
Equity, negative equity and refinancing
Your equity is how much of your home you actually own. It's the value of the property, minus any mortgage debt you still owe.
Negative equity occurs when you only own a small portion of your home and then your home loses value. This can happen during a property crash or market downturn, or if your property is damaged in some way.
Ending up with a property and a home loan with negative equity can happen for a few different reasons, including when:
- You bought your property recently, then property prices drop.
- You co-own the property and need to buy the other partner out due to relationship breakdown, but your portion of ownership leaves you with very little equity.
Here's an example of how borrowers can end up trying to refinance with no equity.
Example: Glen and Sara
- Glenn and Sara bought an inner city apartment for $600,000 in 2019 with a 5% deposit, worth $30,000.
- They have a loan worth $570,000, which they fixed into an interest rate of 3.99% for two years.
- In 2021, their loan is coming out of the fixed rate period. They would like to refinance to home loan with a cheaper interest rate.
- They decide to refinance and get a property valuation. Unfortunately, because apartments are over-supplied, the property hasn't grown in value.
- In fact, the valuation shows the property's value is now just $580,000.
- They have paid just $10,000 off the loan principal, so their home loan is $560,000.
- Glenn and Sara are stuck with just $20,000 equity in the property.
If Glen and Sara's property was valued less than $560,000, the current value of their home, then they would be in negative equity.
Glen and Sara will need to pay off more of the their debt before they can think about switching to a better loan.
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How can you refinance without equity?
- Consider specialist lenders. If you're looking to refinance and you've only built up a small amount of equity in your home, think about refinancing to specialist lenders or building societies. These lenders may have more lenient eligibility criteria when it comes to determining your serviceability potential. If you can demonstrate that you have enough savings, income or assets to service the loan, the lender may overlook the minimal amount of equity that you have.
- Find a guarantor. With a small amount of equity in your existing home, you may want to refinance to a guarantor loan. This can boost your borrowing capacity as the guarantor essentially takes responsibility for servicing the loan if you default.
- Get an independent valuation. If you can prove that your property has increased in value, then the lender may be more inclined to let you refinance and borrow a larger amount of funds.
- Request a copy of your credit file. With a small amount of equity, you present a larger risk to the lender. This is why it may be a good idea to take measures to trim your existing debt and clean up your credit file. If you can show the lender that you make a conscious effort to meet your repayments on time and make extra repayments in the past, then they may be more likely to approve your refinance application.
Can you refinance with less than 20% equity?
While many lenders will lend you money with just a 5% deposit, you usually need at least 20% to refinance.
You could refinance with less than 20% equity, but you'd probably need to pay lenders mortgage insurance on top. This is true even if you paid lenders mortgage insurance the first time round.
Learn more about the amount of equity that you need to refinance your mortgage.
What are the alternatives to refinancing without equity?
If you're unable to refinance then you might have to simply build equity by paying off more of your mortgage.
- Make extra repayments. Easier said than done, but if you have extra cash or other assets you can sell to help reduce your mortgage then you could build enough equity to refinance your mortgage.
- Add value to your property. Renovating the property could add value, if done correctly. You need to work out what renovations will add value and how affordable those renovations are. If you have handyman skills or know someone who does this could be a good option.
- Rent it out. You could rent out a room in the property to bring in extra money to help make repayments. It might not be an ideal option, but for some people it might be worth it.
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