How to use equity to buy an investment property
- How much can you borrow?
- Equity versus usable equity
- 3 key tips on how to use equity to buy property
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You can buy a second home or investment property without cash for a deposit by using the home equity in your existing property. Sounds amazing? Here’s how it works.
You do this by borrowing against the equity through a refinance to borrow more money.
For instance, if your home is worth $500,000 and you owe $200,000 on your home loan, you have $300,000 in equity.
However, this isn’t always the most accurate way of assessing your borrowing potential, as there are other important considerations that we’ll cover below.
What is the difference between a second home and an investment property?
A second home is a one-unit property that you intend to live in for at least part of the year or visit on a regular basis.
Investment properties are typically purchased for generating rental income and are occupied by tenants for the majority of the year.
Investment properties are looked at differently than owner-occupier properties due to their ability to generate income, appreciate further in earning potential as the property increases in value, and provide certain tax benefits to the investor.
Simply put, unlike buying a home to live in, an investment property is usually bought with the goal of making money. And while investing in property is a popular way to invest money in Australia, think about whether it fits with your circumstances before committing to it.
What is equity?
Equity is the difference between the market value of your home and the outstanding amount you owe to the bank.
For example, if a home is worth $500,000 and has $300,000 to be repaid on the home loan, the equity in the house would be the difference between the two amounts, that is, $200,000.
So, is this the full amount of usable equity?
No. Banks don’t like to take risks and they will not allow you to use up all the equity in your home. You can calculate your usable equity as 80% of the value of your home minus the amount you owe to the bank.
In this example, the usable equity would be $400,000 (80% of $500,000) minus $300,000, which is equal to $100,000.
LMI and how much you can afford to spend
When it comes to buying an investment property, it can be hard to know where to start. But a simple rule of thumb is just to multiply your usable equity by four to arrive at the answer.
For example, four multiplied by $100,000 means your maximum purchase price for an investment property is $400,000.
Some banks may allow you to cash in more than 80% of your equity if you take out Lenders Mortgage Insurance (LMI).
How much can you borrow?
To calculate the amount you could borrow for your investment property using equity, simply multiply the usable equity by four. In the example above, you could borrow $400,000 using $100,000 of usable equity to cover your 20% deposit and 5% accessory costs.
What to remember before you dip into the equity pool:
- Don’t use up the entire available equity in one go.
- Don’t lose focus on paying your home loan as fast as possible.
- Sound financial advice is key to sound investment. Only invest if you can afford the repayments.
- Having usable equity does not mean you will always get an investment loan.
Banks will typically lend you 80% of the value of your home, minus the debt you still owe against it. This is considered your usable equity.
Since the bank is lending you money against the value of your home, they won’t lend you the full amount. If house prices dip, they don’t want an outstanding loan that’s worth more than your property.
3 quick tips on how to use equity to buy an investment property
- Find out the value of your house. Often, your house isn’t worth as much as you think. Get in touch with a professional appraiser to know the actual value of your property and calculate what you can afford for your future investment.
- Contact lenders and compare every deal you can find Contact lenders or compare deals online to get the best home loan rates in the market. In case you spot a great deal, why not refinance your existing loan as well?
- Speak to the experts or a broker Using a professional appraiser and a financial advisor can help you make an informed decision on your future property goals, and a broker who can help you ensure your application is air-tight is usually very easy to find.
How to use your available equity to buy a property
Once you have worked out your available equity, it is time to consider your loan options.
This is a good opportunity to perform a financial health check on your home loan and other loans you may have against your property portfolio.
Items you have to check up on include:
- The current interest rate you are paying compared to other lenders and the current fixed rates vs variable rates
- Fees and structures compared against other lenders
- Whether other lenders could offer you a better service based on your current portfolio and loan structure.
If you decide to go ahead and access some of your equity, you will need to see if it will result in any extra fees and charges - for example, lenders' mortgage insurance or associated fees if you decide to switch to another lender.
Once you have decided on the best option, it is time to contact a lender and get the process started.
Using a mortgage broker has many benefits for you as a property investor.
Brokers have access to many different lenders and loan products through their lending pool and can save you plenty of time and stress by doing the research for you, and applying for your next property investment loan on your behalf.
Shopping around for the right loan can save you thousands of dollars in interest and fees.
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Written by
Loans Expert
Shaun McGowan
Reviewed by
Editor
Sean Callery
