A question I often get asked is how can do I 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. 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 what the current value of a property is, and any amount owing on that property (for example the mortgage amount).
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 possible that the value of your home has increased during this time. You may also be paying down your mortgage so that the amount owing on your home loan is reducing. This results in a situation where you have increasing “equity” accumulating in your home.
Take for example, a home that is worth $500,000. If you only owe $300,000 on the associated loan, then you actually have $200,000 worth of equity!
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). LMI only applies when the amount of borrowed funds exceeds 80% of the value of the 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 $500,000) then we have the ability to borrow up to $400,000 (ie: $500,000 x 0.8). With an existing mortgage in place of $300,000, there is now the potential to use the additional $100,000 as a deposit for an investment property.
But there are some important steps that you need to follow to avoid making a big mistake.
1. Ask your lender to perform a valuation on your existing property to determine it’s current value.
2. Calculate your available equity. Remember this is the Valuation price x 0.8 LESS any existing mortgage owing on the property.
3. Request to re-mortgage or re-finance your existing facility to draw out the equity as cash which you can use as a deposit, or set this up as a separate line of credit (it is advisable to seek the help of a licenced mortgage broker who can assist with this process).
4. 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 to explain!
5. Ensure you can afford the investment as well as any additional repayments that may be necessary to hold that investment property.
Using equity from your home as a deposit for an investment property is a great way to get started in property investment. Using this investment strategy helps you to get started in property investing, 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.