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Investing in property is a great way to build your wealth, and you can use your home equity to get your portfolio started.
Australia is a nation of property investors. Our growing population and housing markets mean property is considered one of our most stable investments. The real hurdle standing between most people and their investment plans is the down payment needed to buy a second or third property.
Many investors choose to build properties in the traditional way – budgeting and saving, putting away money each week until they have a deposit. But, if you already own a property, you can make use of your existing home equity to secure your next investment.
In this article we’ll cover home equity in more detail and help you understand how it can be used to start investing sooner.
What is Home Equity?
‘Home equity’ is simply the difference between the market value of your home and the amount owing on your mortgage. So, if your home is currently worth $500,000, and you still owe $300,000 on your mortgage, your total home equity is $200,000.
Although your lender still owns part of your home through your mortgage, the amount you have already paid off, as well as any capital growth, belongs to you. It may not be quite the same as having $200,000 cash in the bank, but your home equity is money a bank or lender will allow you to access when borrowing.
If you have a big expense in mind you can borrow against your home equity and use the money to do things like:
- Buy an investment property
- Build a home extension
- Invest in your small business
- Purchase a car
- Go on holiday
How much can you borrow?
With any home purchase there is a limit to how much money you’ll be able to borrow.
For investors using their equity to secure a mortgage, banks are typically prepared to lend up to 80% of the current value of your home, minus your outstanding debt. Your exact borrowing limit is based on ‘usable equity’ which depends on the value of your home and the remaining value of your mortgage. So, for example:
- Your home is valued at $500,000
- A bank will lend up to 80% of that value, or $400,000
- Less the $300,000 outstanding on your mortgage, your usable equity is $100,000
Your usable equity can help estimate how much you can borrow for your investment property. The exact amount varies, but a good rule of thumb is to multiply your equity by four, so in this case your $100,000 usable equity will let you borrow up to $400,000 for your next property.
How to buy an investment property using home equity
Using a mortgage to buy your residence is standard procedure – the buyer supplies a 20% deposit, and the bank lends you the remaining 80%.
Using your home equity to build to an investment property works the same way, except you won’t need to save up and pull together a 20% deposit. Instead, you use the equity in your existing home as your deposit on the investment.
To continue our example above, your $100,000 usable equity will cover the 20% deposit paid to the bank for your new investment property.
It’s important to note that buying an investment will incur all the usual fees associated with real estate, like stamp duty and legal costs, so your $100,000 equity needs to cover the deposit as well as those fees.
Lenders Mortgage Insurance
Banks and lenders are increasingly sensitive to the rising cost of housing and the need to make mortgages available to buyers who can’t supply a 20% deposit. When you’re using equity to build an investment property it’s possible to borrow more than 80% of the home’s value if you pay for Lenders Mortgage Insurance (LMI).
LMI is a one-off fee that lenders apply to low deposit mortgage options. It ensures your lender won’t be out of pocket if you default on the mortgage. The cost is typically several thousand dollars, and you will need to meet slightly stricter borrowing criteria, but LMI may allow you to borrow more than 80% of your investment property’s value.
Managing your risk
Although property is one of Australia’s favourite investing options, the market still comes with risks that need to be carefully managed.
When you’re using your home equity to build an investment property, you are using your existing home’s value to help secure another mortgage. In the worst-case scenario where the property market dips and you become unable to afford the mortgage on your investment, your lender could be entitled to sell your primary residence to recover any losses on the loan.
We always recommend customers consult a financial advisor and do their own research to figure out if investing in property is the right choice.
Interested in investment opportunities?
If you’ve been thinking about investing in property then there’s no time like the present. Australia’s housing market remains a strong performer and our growing cities are all predicting strong growth over the long-term.
To hear more about investing in your city, or for more information about using your home equity to build an investment property, feel free to contact Privium Homes. Our friendly team will be happy to explore your options and answer any questions you may have about the process.