What is Equity in Property?
When you think back to saving up for your first home, you probably groan internally at how long it took you to save up your deposit.
Because of this, it comes as no surprise that the thought of saving up for another property, while also servicing your current loan, feels downright impossible.
Did you know that you may be able to use the equity in your home to invest in your next property?
Apart from using equity to make another investment, you may also be able to use equity for home renovations, share portfolios, personal loans and more.
Read on to find out how you can calculate the useable equity in your home, as well as the pros and cons associated with doing so.
What is equity and how do I calculate my usable equity?
The first thing you might be thinking is ‘what is equity?’
We’re glad you asked!
Equity simply refers to the difference between the current value of your home and how much you still owe on it.
For example, if your home is worth $600,000 and you still owe $420,000, your equity is $180,000.
Within the equity in your home, there is a way that you can calculate your ‘useable equity,’ which is the equity you can use to invest elsewhere.
Inovayt’s Senior Mortgage Broker Melbourne, James Rae says that to calculate the useable equity in your home, you need to divide the loan amount by the value of the home.
For example, a $500,000 loan divided by an estimated home value of $800,000 = 62.5 per cent.
This then equates to $140,000 in equity at an 80 per cent loan-to-value ratio (LVR).
James says these funds can then be used to invest in an investment property or share portfolio.
What are the pros and cons of investing with equity?
Like with any major decision, it’s time to weigh up the pros and cons when deciding whether to invest with your existing equity, including what type of investment is right for you.
- James says one of the biggest benefits of using your equity to invest is that it allows you to start your investment journey now as opposed to having to save enough money to purchase an investment or start a share portfolio.
- Using the equity in your home when taking out a loan for an investment property means you can potentially lock in a better interest rate and avoid paying Lender’s Mortgage Insurance (LMI).
- You can use the equity in your home to invest in several different things, including property renovations, investing in shares, car or boat purchases, overseas trips and more.
- If using the equity for renovations, the renovations (once completed) may be able to add value to your home, which will increase equity in the long term.
- Taking out too much money and essentially ‘biting off more than you can chew’ may land you in a bit of hot water if you don’t have backup funds available in the event that something goes wrong.
- Another potential downside according to James is if the investment makes a loss, the debt will remain secured against your home while still needing to be repaid.
- There are a few factors lenders will take into consideration when you request to use the equity in your home. These factors are like the ones looked at when you purchased your current home and include your income, general living expenses, number of children or dependants, current debts etc.
- An important factor to note is that if you are taking equity from one property to purchase another, the structure of your loans will dictate if the property will be taken as additional security or not – also known as cross-securitisation.
How do I build equity in my existing home?
There are a few ways you can build equity into your existing home if you are trying to get enough equity in it to purchase an investment property or one of the other options available to you.
The first way is to make more regular, larger repayments to reduce your loan balance.
This will bring down the first factor in the example provided by James about how to calculate your useable equity. In other words, your useable equity value will increase.
Create equity through property improvements
Secondly, you can increase the value of your home by making renovations.
While you may be thinking that paying for renovations might be too expensive, you may potentially be able to access some of the equity in your home to undertake these renovations.
This can be done to extend or redevelop your current living arrangements, to fix up or modernise current parts of your home, spruce up your outdoor area, add a pool, or even subdivide.
In the long run, this can add value and equity to your property.
Another way that equity builds in your home is through changes in the market.
“Equity builds as the value of your home increases due to market activity in your area,” James says.
If the market is running hot (like it is right now!) there is a chance the equity in your home will rise significantly higher than when the market is experiencing a slower growth period.
How much deposit is required to purchase an investment property with equity?
To purchase a second or investment property it is important to keep in mind that a minimum 10 per cent purchase price (plus costs) is needed when using equity to purchase a second property.
Who should I speak to about using equity to buy an investment property?
Using the equity in your home may be a way for you to get into the investment property market sooner without having to save up again for a deposit, as well as giving you the chance to invest in shares, take out a personal loan or add value to your current property through renovations.