Using equity to buy property

 

Investing in property can be a strategic and beneficial move toward building long-term wealth and financial security. If you don’t have savings to purchase a property, using equity to buy property can be another way to access money and achieve your goals sooner.

What is equity?

Simply put, equity is the difference between the current value of your home and how much you still owe on your home loan. For example, let’s say your home is worth $1.8m and the current balance of your home loan is $600,000 you would have $1.2m worth of equity in your home.

Equity does take time to accumulate, but with every mortgage repayment made you are in fact building additional equity within your home. Chances are that if you have owned your home for a few years you would have built up equity already. Even if your home loan balance has stayed the same for various reasons, the value of your property may have increased due to rising property prices or renovations you may have made. In this case, you still might have equity that can be used to buy property. Think of your home like an asset, lenders and banks will often let you access equity to buy property or to renovate, start a business, buy a car or go on a holiday.

What is the difference between total equity and usable equity?

It is important to remember that there is a difference between total equity and usable equity. One common misconception is that people think they can utilise all the equity in their home, and this isn’t the case as lenders won’t lend you the full amount. Typically, you will only be able to access 80% of the market value of your property.

Using the same example from above if your home is worth $1.8m and you still owe $600,000 on your home loan, your total equity is $1.2m. However, your usable equity is only 80% calculated as $1,800,000 x 80% – $600,000 = $840,000 of usable equity.

Whilst the usable equity is a lower amount it is still a sizeable sum to put toward purchasing property. If your usable equity isn’t enough to cover the total costs of buying an investment property including the deposit, stamp duty and settlement costs, then you will likely have to add additional cash funds. Alternatively, you could consider purchasing a property with a deposit lower than 20%, but then you would also be required to pay Lenders Mortgage Insurance.

Using equity to buy an investment property or a second home

If you are looking to use equity to buy a property, then working with a mortgage broker who can help you navigate the process is recommended.

Step 1: Work out your usable equity

This is where working with a property finance specialist can be advantageous as they will have access to a large pool of lenders and be able to organise several valuations of your home to determine the current market value. Valuations can vary from lender to lender which is why comparing lenders is important. Once the market value of your home has been determined a mortgage broker will be able to work out your total equity as well as your usable equity. They will also consider your income and any other debts you might have to work out the amount of equity you can access.

Step 2: Establish a purchase price range

Different lenders will have different requirements and the amount you may be able to borrow will vary from lender to lender. Your mortgage broker will be able to approach various lenders to find the best loan option for your individual circumstances and determine how much you have to spend on an investment property. They will also be able to work alongside your accountant or financial planner to ensure your new loan is structured in a tax effective manner. Some property investors use the ‘rule of four,’ meaning the purchase price of the property should be no more than four times your usable equity to allow for a 20% deposit, stamp duty and other fees.

Step 3: Review your loan options

It is important to find the right home loan and a lender you can trust when buying property. If you have engaged the services of a mortgage broker they will do the hard work for you.

Step 4: Work out the costs of accessing equity

When accessing equity, in most cases you will either need to refinance your existing home loan or increase your current home loan. If you are changing lenders or taking out a separate loan then there may be additional fees that you need to be aware of such as legal fees, break costs, loan application fees etc. Equally, if you are buying a property with less than a 20% deposit you may  also need to pay Lenders Mortgage Insurance unless you qualify for an LMI waiver.

Step 5: Loan application and settlement

Once you have settled on which loan option you are proceeding with your mortgage broker will work with you handling the application process and all requirements right through to settlement and beyond.

Pros of using equity to buy an investment property or second home

Avoid paying LMI

Using equity to buy property can help you avoid paying Lenders Mortgage Insurance. However, as we have discussed, if your deposit is lower than 20% then you will likely have to pay LMI.

Improved cashflow

Using equity can enable you to buy property sooner rather than later without having to tap into your savings.

Better loan terms

Changing to a different loan option if you are refinancing your home loan can allow you to find an option with better loan terms, ultimately saving you money over the life of the loan.

Cons of using equity to buy an investment property or second home

Your properties become linked

When you use the equity in your home to finance a second property your properties can become linked unless the applications are structured correctly, which means any decisions for either property can affect the other. It is important to ensure that the application to access the equity in your existing property be separate to the application made for the new purchase. Different lenders can also be used for each application.

Increased repayments

Accessing your usable equity will add a lump sum back onto the amount you need to repay which will likely increase your repayments. However, any rental income you receive can be used to partially offset your repayment amounts.

What to consider before using equity for property investment?

Using equity for property investment can help you achieve your goals, but as with any investment, it is important to weigh up the pros and cons. With any property purchase, there are repayments, fees and taxes etc which you need to ensure your finances can cover.

Consider your long-term goals and make sure you have savings set aside to cover any repair work, if you are between tenancies, or in the event your tenant stops paying rent.

Working with a financial planner or advisor can be helpful to work out your goals and a plan for managing your finances. Your mortgage broker can also work with you to set up different loan rates for each property to maintain your cashflow accordingly. Keep in mind there are tax deductions associated with owning an investment property, negative and positive gearing, depending on your income and personal circumstances.

Other uses for home equity

Renovating your current home

You can also use equity to renovate your current home. Whether you want to add value to your home, extend your home because of your expanding family, or update and modernise your home, using equity can allow you to do this without accessing your savings.

Other investments

Equity can also be used for other means of investing such as shares, bonds, or managed funds. Speaking with your financial advisor to determine your goals and risk profile can be helpful when looking to create a wealth strategy.

Personal use and debt consolidation

Lenders can also consider applications to access equity for personal uses such as the purchase of a vehicle or the repayment of an existing loan such as car loan, personal loan or outstanding credit card debt.

FAQs about using equity to buy property

Do I need to pay off my home loan before I can access my equity?

No, you can still access equity whilst paying off your home loan.

Should I access all my accessible equity to buy an investment property?

It is often better to play it safe and to allow a buffer in case things don’t go to plan, especially if you don’t have any other savings as a backup. Reducing risk and protecting yourself by not using all your available equity can help cover any unexpected future costs or life changes. Speaking with your financial planner and mortgage broker can help you work out what is best for your circumstances.

How can I build equity?

Some ways you can build equity aside from paying down your home loan include:

• Make extra repayments to pay down your home loan sooner if your loan terms allow.
• Increase the value of your home through renovations.
• Consider using an offset account to reduce the interest you need to pay and make your repayments go further.

How long do I have to wait until I have enough equity to buy a property?

This depends on the equity you already have and the cost of the property you want to buy. This is where a mortgage broker is best placed to provide the right advice for your individual circumstances.

How much deposit will I need to secure my next property?

Ideally, you should aim to have a 20% deposit, this will allow you to avoid Lenders Mortgage Insurance. Keep in mind your usable equity is 80% of the current value of your property minus what you have left owing on your home loan. If your usable equity is not enough to cover the deposit and additional costs associated with purchasing property you will need to make up the difference.

What is a valuation report?

A valuation report outlines the current value of a property at the time of the report based on its attributes, size, construction and recent sales of similar properties in the area.

Can I get pre-approval for my investment property funded with home equity?

Yes, you can. Pre-approval can be a great way to determine if your chosen lender will allow you to use the equity in your home to buy property. Remember pre-approval doesn’t guarantee your loan will be approved.

How does equity work when buying an investment property?

Rather than paying a cash deposit borrowers can use the equity in their home to purchase property and act as security against the loan.

 

If you would like to find out more information about potentially using the equity in your home to buy property, or to fund renovations to your existing home, or for any other reason the team at Townsend Wealth can help you find the best path forward for your goals. We help homeowners all across Sydney including North Sydney and the Northern Beaches.