If you’re planning on investing but haven’t yet secured the deposit, you need to know how equity works when buying a second home.
Whether you’re interested in a holiday home for Christmas or an investment property to bring in additional income, using the equity from your first home means freeing up the money you would’ve used for a deposit to utilise elsewhere.
It seems too good to be true, right?
Of course, there are always pros and cons to everything.
So, we have compiled a comprehensive guide on using the equity in your existing home to buy a second property.
What Is Home Equity?
Equity is the difference between a home buyer’s property value and the amount they still owe on their loan.
You’ll need to have your property reevaluated to calculate the current value of your home.
Lucy bought her first property investment ten years ago for $600,000. She was able to pay a cash deposit of $100,000 and secured the rest of the cost with a loan of $500,000.
She paid her monthly mortgage for ten years, which amounted to $150,000. Therefore, she had contributed $250,000 towards her property investment in total.
During that time, the property value increased to $650,000.
So, when calculating how much she still owed, Lucy used the following formula:
Home’s original price – (Deposit + Total mortgage paid so far) =
How much you owe
$600,000 – ($100,000 + $150,000) = $350,000
From there, she could calculate how much equity she had in her current property:
Home’s market value – How much you owe = Home equity
$650,000 – $350,000 = $300,000
Therefore, Lucy had $300,000 of equity that she could use towards buying a new investment property.
But, it’s worth noting that the bank won’t allow you to access 100% of the equity in your home to buy your new investment property.
How Do Banks Calculate Home Loan Equity?
Banks generally only allow borrowers to access 80% of their property’s value after subtracting their outstanding debt.
A lender sets these rules so that they’re able to keep some of that equity as security.
So your available home equity, for loan purposes, will be less than your actual home equity.
Lucy calculated that she has $300,000 worth of equity in her current property.
The bank will only let her use 80% of her equity less the home loan outstanding balance for her new credit.
So, to work out how much available equity she has, she uses the following formula:
(80% x market value of property) – home loan’s outstanding balance =
available equity loan
(80% x $650,000) – $350,000 = $220,000
Lucy will be using her equity to buy her second investment property. The bank will let her use $220,000, which she can put towards the deposit of her second property.
Checklist: How Do I Access My Home Equity?
Once you can tick all of these things off the list, you can begin refinancing your property to access your home equity.
- I have paid off more than 20% of my current property value.
Banks require borrowers to have paid off at least 20% of the new value of the house after being reevaluated. So, if you combine your deposit and how much you have paid until today, it should be 20% (or more) of how much your home was reevaluated, this is on the assumption that your property price has gone up.
- I have never missed a mortgage repayment.
If you maintain your end of the home loan deal, banks are more likely to trust you in future and ensure that you have a high borrowing power.
- I am securely employed and can provide my two last payslips.
The bank needs security that you’re in a situation where you can comfortably continue paying off your home loan.
- I have no discrepancies in my loans
This is also just security to the bank that you will honour your repayments as you haven’t been in any trouble in the past.
How to Access Your Property’s Equity
Refinancing your existing home loans is a common way to release its equity.
You can do it through your current lender or shop around for the best deal.
You’ll need to be cautious, though, as many people choose to refinance their house in the hope of getting a better interest rate. This would be a great added benefit for you – provided that the current interest rate is in fact below your original one.
Why Should You Buy New Property With the Equity in Your Home?
You can buy a property with no deposit if you put down your home equity instead.
If your deposit equals 20% of the property you want to buy, you won’t need to spend any extra money on lenders mortgage insurance (LMI).
So, if your available home equity is $220,000, you could buy a property to the value of $1,100,000 and only have to pay off a home loan of $880,000. But please also account for stamp duty.
Of course, this is dependent on whether you can afford to service the loan.
How To Increase the Home Equity in Your Property
Before you use the equity from your home, why not try to increase the value of the property? Here are some things you could do to increase your equity:
Renovations and Home Improvement
Renovations can add value to your property if you:
- add extra bathrooms;
- knock down some walls to make it more open plan;
- increase cupboard space;
- add a fresh coat of paint;
- repair your roof or tiles (if necessary); and
- Improve your landscaping.
Inject Cash Into Your Principal
The smaller the gap between the money you owe and the market value of your property, the higher your equity will be.
However, you’ll need to check with mortgage brokers to establish if your loan’s features allow you to make additional lump sum repayments.
Link an Offset Account
If your current home loan has the feature of an offset account, you can use this account as a savings account.
It’s offset against your home loan account to reduce interest, and the money you save on interest you can use to put back into the loan and increase your equity.
Things To Consider When Using Your Home Equity To Buy a Second Property
While it sounds like a fantastic idea, it’s important to consider carefully before applying.
Remember, every application reflects on your credit file, so it’s worth being completely certain of what you’re getting yourself into and whether you’re ready.
Some questions to ask yourself:
- Do you have enough money to pay for two mortgages at the same time?
- How is your cashflow ?
- Do you have extra money on hand for any emergencies?
- Will you be able to afford interest rate increases if you’re on a variable rate home loan?
- If you are planning on renting out either property, do you have enough money to cover times when the house might be vacant?
- Do you have enough money for the property purchase costs, such as:
- Stamp duty
- Property title transfer fee
- Registration fee
- Conveyancing fees
- Inspection fees
The more money you put down on your first home, the higher its equity will be. Using that equity to buy a second home means that you could do so without using your own cash.
There is a checklist to work through before being ready to access your home equity. Ensure it’s a good time in the market to be refinancing your home loan.
Using your home equity when buying a second property seems obvious, but don’t forget to weigh all the risks.
Talking to a mortgage broker will give you the best understanding of the consequences of this strategy.
Get in touch with one of our professionals from The Mortgage Agency today, and begin your journey of buying your second property.
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.