Leveraging the equity in your home to purchase an investment property is a popular strategy for many investors. Using a home equity loan, you can tap into the value of your existing property to fund a new property investment.
This approach can help you grow your real estate portfolio, potentially leading to increased financial security and passive income
What is Equity?
Equity is the difference between the current value of your home and how much you owe on your mortgage. For example, if your home is worth $400,000 and you still owe $220,000, your equity is $180,000.
Using Equity as Security
You can use equity as security with the banks, meaning you can borrow against your equity to fund big purchases, such as:
- Extending your home
- Starting a business
- Buying a car
- Going on a holiday
You can also use equity to buy an investment property and get into the real estate market.
Total Equity and Useable Equity
Banks typically lend you 80% of the value of your home, minus the debt you still owe on it. This is called your useable equity. For example, if your home is worth $400,000, the bank might lend you up to $320,000 (80% of $400,000), but they will subtract the $220,000 you still owe, giving you $100,000 in useable equity.
The bank won’t lend you the full amount because they want to ensure the loan isn’t worth more than your property if house prices go down. However, it’s possible to borrow more than 80% of your home’s value if you take out Lenders’ Mortgage Insurance (LMI).
How Much Could You Borrow for an Investment Property?
Let’s say your home is valued at $400,000, and your mortgage is $220,000. Here’s how you calculate your useable equity:
- Value of your property: $400,000
- 80% of your property’s value: $320,000
- Minus your mortgage: $220,000
This gives you $100,000 in useable equity.
Using the “Rule of Four”
When buying an investment property, it helps to know how much you can afford. A simple way to estimate this is by using the “rule of four.” Multiply your useable equity by four to find the maximum price you can pay for an investment property.
For example, if you have $100,000 in useable equity, four times that amount is $400,000. So, you can potentially buy an investment property worth $400,000.
Why Use Four and Not Five?
If you want to buy an investment property for $400,000, the bank will lend you 80% of the property’s value, which is $320,000. This leaves a gap of $80,000, which is the amount you need for a deposit.
But you also need to budget for additional costs like stamp duty and legal fees. These costs are usually about 5% of the property price, or around $20,000 for a $400,000 property.
So, to buy a $400,000 investment property, you need $80,000 for the deposit plus $20,000 for extra costs, totaling $100,000.
Final Tips
Even if you have a lot of equity, you might not always be able to borrow against it. The bank will look at several factors, such as:
- Your income
- Your age
- How many kids you have
- Any other debts you have
It’s important to play it safe. If you don’t have any savings outside of your home equity, using all of your usable equity to invest in property can be risky.
You should always keep a buffer – some extra funds in case things don’t go as planned. Even if this means you have to wait before investing, it’s crucial to protect yourself financially.
Using equity to buy an investment property can be a smart move, but it’s wise to talk to your banker or broker first to make sure it’s the right strategy for you.
Count on experts to help you make wise investments. A financial advisor can guide you in making the right financial decisions.
To find out if our strategies are right for you, feel free to contact 360 Financial Strategists online or on 03 9427 0855.
