Are you watching others around you build their property portfolios and wondering how to buy your own investment property without blowing all your savings? If you own a home, you may be able to harness the power of your home equity to get a kick start.
Let’s explore what you need to know about accessing home equity to purchase your first or next investment property.
What is home equity?
Home equity is the difference between your home’s market value and the amount you still owe on your mortgage.
For example, if your home is worth $400,000 and you owe $250,000 on your mortgage, a lender may typically allow you to access up to 80% of the property value minus the mortgage. In this case, 80% of $400,000 is $320,000, minus the $250,000 mortgage would give the borrower a useable equity of $70,000.
The equity in a property typically grows in one of two ways; through reducing your loan balance by making your regular mortgage repayments over a number of years, or if your property experiences capital growth.
However, you may be able to speed along the process of increasing your home equity by working to reduce the loan balance through extra repayments or renovating or upgrading the property.
How do you access home equity for an investment property?
You may be able to access the equity in your home to use as security to borrow money, such as to take out an investor home loan. This is typically done through refinancing and “topping up” your home loan or you could consider cross-collateralisation.
Refinancing your home loan may allow you to increase the loan amount and use the new funds as a deposit for the investment property. By topping up your home loan, you are increasing your debt and ultimately the interest you otherwise would have paid on the original loan, but it does eliminate the need for a deposit.
Some budding investors may want to consider the strategy of cross-collateralisation, which involves using your current property as collateral and adding it to a new investment home loan. Borrowers will then have two home loans to repay, their original home loan and a new home loan that is secured by the existing property as well as the investment property.
By using the existing property as collateral for an investment loan, you will have less flexibility than if you had two un-linked home loans, particularly if you wanted to sell the existing property. This can create more paperwork in terms of writing a third, new home loan for the investment property (that you will still need to qualify for) and can crease issues if the sale of the existing property offers low or poor returns.
Risks of accessing equity for an investment property
Financial planner Deborah Kent, owner of Integra Financial Services, said using your existing home equity is an accessible way to enter the property market. However, she advises caution before making the leap.
“You really have to do the numbers and look at all the costs owning property entails,” she said.
“If you are buying an apartment, look at costs such as strata fees, how much money is in the sinking fund, whether the building is old and will need work in the near future. All these expenses impinge on your investment return.”
“If you are buying a house, keep in mind that while any maintenance you do is tax deductible, if you’re paying $2,500 on maintenance, you’ll potentially get only half of that back.”
“The number one rule of financial planning is to pay off your own mortgage because you do not receive any tax breaks,” she said.
“But if you are in a bracket where your income is high and you have good cash flow, there is no reason not to use your home equity to buy an investment property,” Ms Kent said.