What is equity and how does it work?Your equity in your home is how much of it you actually own. For instance, if your home is worth $750,000 and you owe $350,000 on your home loan, your equity is $400,000.
You may be able to use some of this amount – although probably not all of it – to fund the purchase of another property.
How much equity do you need?Lenders are typically happy to lend up to 20% of a home’s value without lenders mortgage insurance (LMI). So, your usable equity is the total equity you own minus the 20% of the value of your home.
For instance, in the same scenario your usable equity would be:
$400,000 – (20% x $750,000) = $400,000 – $150,000 = $250,000
That means, in this scenario, you may be able to borrow as much as $250,000 to buy an investment property. Depending on your lender, by taking out LMI you could potentially borrow even more.
How much can I borrow using the equity in my home?Just like when you bought your first home, a lender will most likely lend you up to 80% of your investment property’s value with a home loan – although, again, they may lend you more with LMI.
That means once you’ve worked out the usable equity in your home, you can get a rough estimate of what you can afford to buy simply by multiplying your usable equity by four. So, in this same scenario, you’d be able to spend 4 x $250,000 or $1,000,000, with a 20% deposit of $250,000.
Using equity to build a property portfolioIf you take out a principal and interest home loan, you will soon start building equity in your investment property, just as you are in your home. Your equity will also rise if the value of your properties goes up. This means you’ll have more usable equity that you can draw on to purchase another investment property.
Over time, as you keep using this approach and adding properties to your portfolio, it will have a compounding effect. Each time the market rises, your property wealth and your usable equity rise even more. Conversely, each time the market falls, your losses will be greater too.
Should I use my current home loan to purchase an investment property?One of the biggest benefits of buying an investment property is often the opportunity to offset the interest and other expenses you pay against your income. If you use your existing home loan to fund your investment property you may not be able to do this.
For this reason, you should always speak to a financial adviser or other finance professional before you use this strategy to buy an investment property.