Have you ever thought about turning your home into a wealth-building machine? Many homeowners are sitting on a gold mine without even realising it.
The key to unlocking your home’s wealth-building potential lies in understanding how to tap into its equity to purchase your next property.
So, in this article, we’ll explore how to use equity to buy an investment property.
Understanding Equity and How It Works
In simple terms, equity refers to the difference between your property’s current market value and the outstanding balance on your mortgage.
As you pay off your loan and your property’s value increases, your equity grows, too. But how does that translate into real numbers?
Here’s an example.
Let’s say you bought a house five years ago for $500,000, and you’ve been diligently paying off your mortgage ever since.
Fast forward to today, and you’ve managed to pay down $200,000 of the original loan amount. At the same time, your property’s current value has risen to $600,000.
So, how much equity would you now hold?
In this scenario, your equity would be $300,000 ($600,000 market value – $400,000 remaining loan balance).
How Equity Will Influence the Potential of Property Investors
Now, why would you need to know what equity is?
Well, a lender will allow you to tap into the available equity in your property to renovate it, perform debt consolidation, or even buy a new property.
Unfortunately, you can’t access all of the equity at once, as banks and lenders typically limit the amount of equity you can use for investment purposes, often capped at 80% of your property’s value.
For example, in our previous scenario, you’d have access to $240,000 in usable equity (80% of $600,000 = $480,000 – $400,000 remaining loan balance).
How Can an Existing Homeowner Use Equity to Fund a Property Investment
Now that we’ve established what equity is, let’s dive into the exciting part – accessing your equity to buy an investment property.
Two common ways to tap into your equity are by refinancing your existing home loan or topping up your current loan.
Refinancing Your Existing Home Loan
Refinancing involves replacing your current mortgage with a new loan, usually at a more competitive interest rate or with better terms. When you refinance, you can borrow against the equity you’ve built up in your home.
For example, if your home is valued at $600,000 and you have $400,000 remaining on your mortgage, you can refinance and borrow up to 80% of your home’s value ($480,000) and access the difference ($80,000).
Topping Up Your Existing Loan To Finance an Investment Loan
Another option is to “top up” your current mortgage, increasing the loan amount to access your equity.
Using this method can be a convenient way to tap into your home equity without completely changing your home loan.
For example, if you have $240,000 in usable equity, you could request that your mortgage broker or existing lender increase your mortgage by $240,000.
Once you’ve accessed your equity from your existing property through either refinancing or topping up, you can use the extra funds as a deposit to secure a new loan for your investment property.
The advantage of using equity as a deposit is that it can potentially reduce or eliminate the need to save for a cash deposit and help you avoid paying Lenders’ Mortgage Insurance (LMI).
For example, as mentioned earlier, let’s say you have $240,000 in usable equity.
You choose to refinance your existing mortgage, and the bank approves a new loan for $565,000 ($400,000 remaining balance + $165,000 equity).
With the refinanced loan, you can use the $165,000 portion as a deposit for an investment property worth $825,000.
Once you have access to the funds for the deposit from your refinanced home loan, you’ll need to apply for a separate loan to cover the remaining balance on your new investment. In this case, you’ll be seeking a loan amount of $660,000.
You may be interested in reading our Guide to Investor Loans for Investment Properties.
What Should You Consider Before Using Equity to Buy an Investment Property?
While using equity to buy an investment property can be a powerful wealth-building strategy, you must consider several factors before jumping in.
The more time you spend evaluating these aspects, the more likely you are to make informed financial decisions aligning with your goals.
Assess Your Financial Position
Before tapping into your property equity levels, closely examine your current financial situation:
Are you comfortable with your debt levels?
- Do you have a stable income?
- Do you have sufficient savings for emergencies?
- Can you afford to pay interest on another loan?
The best way to prepare for the additional mortgage and unexpected expenses is to carefully analyse your finances.
Consider the Risks of Investing
As with any investment, there are risks involved in purchasing an investment property. These can include property value fluctuations, changing interest rates, and potential vacancies or tenant issues.
So, you need to understand these risks and determine if this investment strategy aligns with your risk tolerance and long-term objectives.
Calculate the Cost
A home loan isn’t your only expense when buying property. There are various expenses beyond the purchase price, such as stamp duty, other government fees, conveyancing fees, and property management costs.
Factor these into your calculations to ensure you clearly understand the total investment required and can plan your finances accordingly.
Research the Market
Conduct thorough research on the property market to identify areas with strong growth potential and high rental demand.
Having this information will help you make informed decisions about where to invest and maximise your chances of achieving positive returns.
Seek Professional Advice
Consulting with a mortgage broker, financial advisor, or property expert can provide valuable insights and guidance tailored to your specific situation.
They can help you navigate the complexities of accessing equity and securing an investment property loan, ensuring you make well-informed choices.
Have a Long-Term Plan
Investing in property is typically a long-term strategy, so it’s key to have a clear vision of your
financial goals and a plan for how this investment will help you achieve them.
However, your strategy shouldn’t be static and should involve regular reviews and adjustments as market conditions and personal circumstances change.
- Tapping into your home’s equity to purchase an investment property can be a game-changer for your financial future. However, you must approach this opportunity with a well-informed strategy and the proper support.
- Remember that the success of this endeavour hinges on carefully considering factors such as your financial position, investment risks, associated costs, and market research.
- Armed with this knowledge, you’ll be better equipped to make confident decisions and achieve your long-term property portfolio goals.
Ready to take the leap and transform your home’s equity into a powerful investment tool?
The Mortgage Agency is here to help. Our team of experienced mortgage brokers is dedicated to guiding you every step of the way, ensuring you make the most of this opportunity.
Book a free discovery session today to find out more.