Many people mistakenly believe you need to pay off all your home loan debt before you can borrow again. This isn’t true.
Many people also often hear, or even use, the phrase "equity in your home"—but don't actually know what it means.
In this article we’ll explore what equity actually is, and how you can use the equity in your existing home to build wealth and to start your journey into investment property.
Looking to buy an investment property but don’t know where to start? Contact Liston Newton Advisory to book a free investment strategy session.
What is home equity?
In terms of property, equity is the difference between the current value of your property and the amount of debt you have against it.
So for example, say your property is currently valued at $1,000,000. If you owe $400,000 on your mortgage, then this means you have $600,000 in equity that you can potentially access.
The good news for investors is that equity can be used as security with banks and lenders. They allow you to borrow against this equity to fund purchases or to use as a deposit for an investment property.
Can I use the equity in my house as a deposit for my investment property?
There are a few common misconceptions when it comes to equity in your home. One big one we regularly hear is that you can use all the equity available when looking to buy your next investment property.
Unfortunately this isn’t true. Banks will only typically lend up to 80% of the value of your home, minus any debt that you still owe.
This final equity figure you can access is known as your usable equity. Here’s how to calculate it, based on a bank lending you 80% of the value of your property.
- Calculate 80% of your property’s value. Based on a $1 million property, this would be $800,000.
- From this figure, take off any debt owed against it. So if you owe $400,000 on your mortgage, this comes to $400,000.
Using these calculations you’ve got $400,000 worth of usable equity available to you. This can be used to put towards your investment property, or cover the typical fees and buying costs associated with buying property.
What value property can I buy using this equity?
A quick way to estimate the value of the investment property you can buy is to divide your usable equity value by 0.25.
So using the above example, if you have $400,000 in equity, you can borrow:
- $400,000 / 0.25 = $1,600,000
We use 0.25, as 20% is required as deposit on your new property, and the remaining 5% is a rough estimate of the associated stamp duty and fees. This may vary from state to state, so be sure to check the exact fees and stamp duty of your state first.
So based on this, if you have $400,000 in equity, you can use this towards the deposit and stamp duty of a new property valued at $1.6 million.
You total debt position would be:
- $400,000 (your existing loan); plus
- $400,000 (your new loan to fund deposit and stamp duty); plus
- $1,280,000 (80% of the loan against your new investment property);
- For a total of $2,080,000.
Servicing your new loan
When it comes to buying investment property, having the deposit for the purchase is one thing—having the income to support your increased loan amount is a different matter entirely.
As you can see in the example above, you need to ensure that your income can support this extra load. In this case, you’re looking at your existing loan ($400,000), your new borrowing amount ($400,000), and the $1,280,000 loan against your new investment property. That’s a total debt of $2,080,000, which is a significant increase.
Your lender will want to be extra sure your income can service this debt without getting into financial difficulty.
There’s good news, though. You can use the prospective rental income from your new investment property as part of the servicing calculations.
To do this, you need to get a rental appraisal from a real estate agent, who can then indicate what the estimated weekly rent may be. So if you receive an estimate of $550 a week in rental income, you can use this in the servicing calculations to gain approval for the new debt amount.
How to access your equity
Now that you’ve determined the equity you’ve got available, the next step is to do your research on current loan options.
At this point, it pays to be thorough—you’re going into even more debt, so you want to get the best loan possible. Be sure to check:
- The interest rate you’re currently paying, and whether you can do better. Look around, and see what other banks and lenders are offering. Make note of the current fixed and variable rates. How does yours stack up?
- The fee structure of your loan, when compared to those of other banks or lenders.
- Any extra fees or charges that you may need to be aware of, such as lenders mortgage insurance.
This lets you know what else is out there, and where you could be getting a better deal on your new loan. You may also find there’s the opportunity for another bank to provide an offer on your existing loan.
Once you’ve decided to access your existing equity to buy an investment property, and you’ve found the best option for your situation, it’s time to get started. The next step is to get in touch with the lender and get the ball rolling.
As a new property investor, you may want to choose to go through a mortgage broker during this process. A mortgage broker will have access to a wider range of loan products and lenders, and they know the business better than anyone. After all, their job is to get you the right loan that you can continue servicing. They do the research for you, and can apply for your investment property loan on your behalf.
They know the ins and outs of navigating the mortgage world—and that the lowest rate isn’t always the best long-term rate. Conditions can vary, it could be a lower-rate introductory offer for a set period of time, and there could be other fine print involved.
So be sure to find a mortgage broker that you trust, and you can be honest with, and feel open to be clear on what you want.
Be mindful when looking to access your equity
Even though it may seem like you’ve got plenty of equity in your home, there are other factors that can work against you in your borrowing power. Banks and lenders take into account other factors. These include:
- The age of you and your partner
- Whether or not you have children
- Your incomes
- Any additional debts against you
The notional amount of equity in your home isn’t a given, so it’s best not to pin all your hopes on that one figure.
Nor is it wise to always extract the maximum value of the equity available to you. Using the entirety of your home equity means you won’t have any extra value or funds available in an emergency, or if things fall through.
It’s recommended to always have emergency funds available. Whether it’s a savings account, liquid assets, or money under the mattress—you need an emergency amount you can fall back on if things go awry.
The final word
Understanding the equity in your home can be a powerful thing. By calculating your useable equity, you’re able to determine the borrowing power you have to purchase an investment property.
You can also use this figure to unlock more equity in your home, whether it’s through paying down debt, or undertaking renovations to add more value.
But while determining your equity to buy an investment property is exciting, you need to be sure you can service the new loan first.
So when looking to use equity in your home to buy an investment property, it’s critical to get the right financial advice.