A property investor’s guide to equity
If you're keen to get on the investment property ladder, the equity you've built up in your own home could hold the key.
You might have thought of your home loan as nothing more than a very long series of monthly payments. But what you've effectively been doing, as you dutifully reduce your debt and as prices in general rise, is gradually building up your home equity – that is, the share of your property value that you own.
Equity is calculated by taking the total value of the property and subtracting the amount you still owe. Let's say the market value of your property is $600,000 and the balance of your mortgage is $400,000. You can subtract the loan balance from the value to work out your equity in the property – $200,000. If the value of your property goes up (whether due to rising property values or because you make improvements), so does your equity.
The good news is, you can access it – without having to sell your home.
Think of home equity as an asset you can use for other financial purposes – whether that's investing, renovating, moving house or funding your next holiday. Lenders will often let you tap into your home equity to use as collateral for new loans. This is a very common strategy for property investors. Done right, it can yield great results – as long as you're aware of the risks.
Before you jump in, here are five things you need to know about harnessing your home equity as an investor.
1. Use it as a deposit
This is one of the better known uses of equity. If you're looking to purchase an investment property, you can avoid the deposit-saving process (or selling your home) by using the equity in your existing property. Your equity could effectively be your deposit.
Your lender will send a valuer to your property to work out the value of your home and from that your lender will let you know what your useable equity is.
Just because you have $200,000 equity doesn't mean you can (or should) use it. Lenders will also consider your income, number of children, debts and other factors. They will usually release up to 80 per cent of your equity, subject to serviceability – in the case of our example, $160,000.
2. Save on lender's mortgage insurance
When buying property, lenders will generally lend you up to 80 per cent of the value of the property you want to buy. You need to chip in with the 20 per cent deposit.
Some lenders, however, will lend up to 95 per cent of your equity, if you're willing to pay lender's mortgage insurance (LMI) on the amount you borrow over 80 per cent. This protects the lender in the event of you defaulting on the loan.
3. Pay down the non-deductible loan first
That is, the mortgage on your own home. The interest on your investment loans is effectively tax deductible, whereas your own home loan isn't – so make it a priority to pay this off fast and first.
4. Your home isn't your only source of equity
If you already have an investment property under your belt, you can also draw down the equity in that to help you finance your next investment. This is how savvy property investors grow their portfolio quickly.
5. Renovate your way to equity
Paying off your mortgage isn't the only way to increase your equity. If you don't have enough equity to finance an investment property, and don't want to fork out for LMI, putting your useable equity towards renovations that will boost the value of your existing property is another option.
With the right additions, you can increase your property's value even in a flat or down market. But depending on what you're upgrading, this can be an expensive exercise, so it's important to weigh up the cost against the expected value increase – and be careful not to overcapitalise with upgrades that are over the top for your area.
Home equity do's and don'ts
- Consider the ongoing costs of owning property, including strata fees and maintenance.
- Look at all your options and shop around. Consult your financial adviser, talk to your family, and get independent advice from a lawyer.
- Forget about the initial costs of purchasing property, such as legal fees and stamp duty. You should factor these into your budget from the beginning.
- Use up all your equity at once. Only release what you need.
- Use all your equity to invest in property if you don't have any other spare funds for emergencies.
With these things in mind, using your home equity to invest in property can be a smart and rewarding strategy. Who knows? This could be the start of an impressive property portfolio. Just go about it carefully – have your budget and buffer in place, and be realistic about the costs and risks. And, as always, speak with your financial adviser before making any decisions.
We're here to help
To find out more about your home loan options, call us on 13 62 27 to speak to a specialist.