Using Home Equity to Buy Investment Property
Home equity is the difference between your property's real market value and the balance of what you owe to the bank on your mortgage.
You may be able to use equity as security with the banks in order to fund an investment property.
How to Calculate Your Equity
Your home is valued at $600,000
Your outstanding mortgage is $400,000
Therefore total equity is $200,000
However, not all of that $200,000 would necessarily be available for you to use.
Many property investors use the term usable equity. This is anything up to 90% of the property’s value minus the outstanding loan amount.
As a general rule, banks will lend up to 90% of the property's value, keeping a 10% buffer to help mitigate their overall risk.
So in our example, 90% of the $600,000 property is $540,000.
Minus the outstanding mortgage of $400,000, would mean equity available to use is $140,000.
However, the final equity amount you can access may be less, as you need to take into consideration lenders mortgage insurance (LMI).
This is a fee charged by a bank or lender when your deposit is less than 20% of your property’s purchase price.
This one-off payment will protect the lender in the event that you, the borrower, cannot make the repayments on your home loan.
This fee can be included in the loan. Talk to your mortgage broker to find out more.
How to Grow Your Equity
Equity in property is generally achieved in one of three ways:
- Reduce the debt by paying down the principal
- Allow time to drive the value of your home up while you merely service the interest component of the loan.
This capital growth can be driven by a number of different factors including population growth, infrastructure and development improvements and supply and demand.
- A combination of one and two; that is, pay down debt as your home appreciates in value.
It is worth noting that when you pay down the principal part of a home loan or an investment loan you may have to go through a fresh (and costly) application process to re-borrow that money back again.
There are other, arguably better but certainly more flexible ways to set up your loans so that surplus cash can be parked against a property loan for as long as you like.
If you’ve owned a home or investment property for a few years, there’s a good chance you may have already built up some reasonable equity; subject to what stage of the property clock you are in the current cycle.
If so, this can potentially be turned into a valuable resource that gives you options to kick start or restart your ability to invest in property.
Another way of using your home equity to buy investment property is to cross-collateralise.
This is where you use the equity from your existing property as security for loans on both properties.
So both your loans will be linked by the fact that the equity in one property is used as the collateral for both properties.
Depending on your individual circumstances, this can be a high risk strategy, because if you are unable to service the loan on one of the properties, then potentially the bank can repossess both.
However, in some situations this strategy might work for you.
For example, if your outstanding debt on your home prevents you from traditional refinancing, cross-collateralisation may be an option worth considering.
Even if you have plenty of equity, you will not necessarily be able to borrow against it.
The bank will take into account lots of different factors such as your income, employment status, number of children and other debts.
Remember to get advice from a qualified professional, who can talk to you about whether using equity to buy investment property is the right option for you.
Ultimately, using home equity to buy investment property can be a smart move and help you on your journey to financial freedom.
But before you get serious, it’s best to talk to your bank or mortgage broker so you know exactly where you stand.
James is Marketing Manager at MRD. He has been investing in property for the last 11 years, and owns properties in Burleigh and Palm Beach on the Gold Coast. He loves family, surfing, gardening and swimming.