A question we often get asked is how can you go about using equity to purchase another property.
Often people don’t think they can afford to buy an investment property because they have not saved enough cash for a deposit. However, cash is not always what is needed. This article will explain the process involved to determine how much equity you may actually have in your home. It will also outline the process to follow so you can get started on your property investment journey, using that equity, without having to save an additional cash deposit.
In terms of property, equity is the difference between the current value of a property is, and any amount owing on that property (for example the mortgage amount). The equity position is based on a bank valuation of the property value (ie: the value determined by an independent valuer who is engaged by the bank) – not the market value of the property (ie: what that property might actually sell for if it was listed for sale)
How to check if using equity to purchase another property is possible for you
If you have owned your home for a number of years, it is very likely that the value of your home has increased since that purchase date. You may also be paying down your mortgage through principal and interest repayments so that the amount owing on your home loan is reducing gradually every month as well. This results in a situation where you have increasing “equity” accumulating in your home.
Take, for example, a home that is worth $1,500,000. If you only owe $500,000 on the associated loan, then you actually have $1,000,000 worth of equity! That would be a very strong equity position when using equity to purchase another property.
Generally, a bank will allow you to borrow up to 80% of the value of a residential property without needing to take out Lenders Mortgage Insurance (LMI). This, of course, is always subject to lending assessment criteria at the time a loan is entered into. LMI only applies when the amount of borrowed funds exceeds 80% of the value of the property when using equity to purchase another property.
What this means is that you can potentially tap into the additional funds that sit in your home as equity. In the example above, if we can borrow up to 80% of the value of the home (being $1,500,000) then we have the ability to borrow up to $1,200,000 (ie: $1,500,000 x 0.8). With an existing mortgage in place of $500,000, there is now the potential to use the additional $700,000 towards the purchase of an investment property.
But there are some important steps that you need to follow to avoid making a big mistake when using equity to purchase another property.
- Ask your lender to perform a valuation on your existing property to determine its current value. As highlighted above, it is not the market value of a property that is used, but the bank valuation amount. There is often a difference!
- Calculate your available equity. Remember this is the Valuation price x 0.8 LESS any existing mortgage owing on the property when using equity to purchase another property.
- Request to re-mortgage or re-finance your existing facility to draw out the equity as cash which you can use as a deposit. Often this is set up as a separate loan facility (it is advisable to seek the help of a licenced mortgage broker who can assist with this process, or work with your lending manager at your preferred bank). It is always a good idea to talk to your accountant about the best structure for tax purposes.
- Avoid cross collateralisation at all costs. This is where your lender will use the security from your home as security for your investment property as well. This exposes the existing property to investment risk and is to be avoided. If you don’t understand what cross collateralisation is – make sure you ask your mortgage broker or bank to explain!
- Ensure you can afford the investment as well as any additional repayments that may be necessary to hold that investment property. Lending assessment criteria will also assess your capacity to repay when using equity to purchase another property.
Using equity from your home as a deposit for an investment property is a great way to get started in property investment without using cash savings. Of course, we always recommend getting advice from your accountant or lending assistant around the best structure for you when using equity to purchase another property.
Using this investment strategy helps you to get started in property investing quickly, without having to save cash that can be used for a deposit. It is a great way you can get ahead and potentially begin your property investment journey.
If you would like any assistance with understanding if property investment is right for you, or how you may be able to better understand using equity to purchase another property, please get in touch with our team.
We look forward to being able to assist.
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