Unlocking equity to invest in property
Equity is one of the most powerful tools you have to start building a solid property portfolio. Many homeowners mistakenly believe that they have to pay off their home loan before they can start investing in property.
WHAT IS EQUITY?
Equity is the difference between the current value of your home and how much you owe on it. For example, if your home is worth $600,000 and you still owe $360,000, your available equity is $240,000. The great thing is, you can use equity as security with the banks. This means you can borrow against your equity to buy an investment property.
TOTAL EQUITY AND USEABLE EQUITY
Banks will typically lend you 80% of the value of your home – less the debt you still owe against it. This is considered your useable equity. Keep in mind that it’s possible to borrow more than 80% if you take out Lenders Mortgage Insurance (LMI).
HOW MUCH CAN YOU BORROW?
Using the example above: $600,000 @ 80% - $360,000 = $120,000 This means your useable equity would be $120,000. As you can see, it’s lower than the $240,000 available equity, but it’s still a hefty amount that you can use to fund your deposit.
USING THE ''RULE OF FOUR"
When it comes to actually buying an investment property, it can be hard to know where to start. But a simple rule of thumb is to multiply your useable equity by four to arrive at the answer. For example, four multiplied by $120,000 means your maximum purchase price for an investment property is $480,000.
To avoid any tax and accounting issues we establish a new loan separate to our current home loan which is the useable equity amount($120k in our example). Then establish a loan secured by the new investment property at 80% of its value($384k in our example) Purchase costs such as stamp duty, legal fees and more is approximately 5% of the purchase price($24k in our example). You can see the useable equity($120K) is sufficient to cover both the 20% deposit($96K) and purchase cost($24k).
Even if you have plenty of equity, it’s not always a given that you can borrow against it. The bank will take into account several factors such as your income, your age, how many kids you have, and any additional debts.
Remember to play it safe. If you don’t have any funds outside your home equity, then it’s risky to use every last cent of your usable equity to invest in property. You always need a buffer – back up funds in case things don’t go to plan. Even if it means you can’t invest for a while, it’s important to keep yourself protected.
Ultimately, using equity to buy an investment property can be a smart move. But before you get serious, it’s best to talk to your mortgage broker, accountant, solicitor and financial planner.