Using your home equity to finance the purchase of an investment property
Did you know you can use the equity in your house to help finance the purchase of an investment property?
What is home equity?
Home equity is the difference between a property’s current market value and any debt held against it. Another way of thinking about it is that it is the proportion of the home that you own outright. And the good news for first-time investors is that it can be used to fund the purchase of an investment property.
You may be able to finance the entire purchase price of your investment property, including any additional costs such as stamp duty and settlement fees. Although this depends on your particular financial circumstances and the amount of equity available in your home.
It’s important to remember, though, that you might not be able to use the entire amount of your available equity, as a dip in property prices could leave you exposed.
If your financial circumstances permit, a bank will more typically lend you 80 per cent of your home’s current value, minus any debt still owing.
What can I use my home equity for?
You can use your home equity:
· to pay for a renovation
· as a deposit for an investment property
· to invest in shares and funds
· to buy a new car, or
· to take your family on holiday.
The amount a bank will lend you depends on the value of your home, your level of debt, your income and expenses.
How to calculate your home’s useable equity
Let’s say your home is worth $500,000 on today’s market and you still owe $200,000 on your mortgage.
Given most banks will likely lend you no more than 80 per cent of your home’s current value, here’s how to calculate your home’s useable equity:
• Your home’s value = $500,000 x 0.80% = $400,000
• The amount of your outstanding loans = $200,000
• Your home’s potential useable equity = $400,000 – $200,000 = $200,000
So, if your home is worth $500,000 and you still owe $200,000 on your mortgage, you have $200,000 of useable equity towards the purchase of an investment property but, you’ll still need to show the bank you can afford the repayments on the full loan amount; which will include both the previous mortgage and the new one.
How much can I spend on my investment property?
You can spend four times the amount of your useable equity on an investment property…at least, that’s the general rule of thumb.
For example, if the potential useable equity on your home is $200,000, you may be able to purchase an investment property worth up to $800,000, inclusive of stamp duty, legal fees and other costs.
This is subject to your ability to afford all repayments.
How much will it cost to access my equity?
There are various factors that can impact the cost of accessing your equity.
If you want to access more than 80 per cent of your useable equity, you’ll need to pay for lender’s mortgage insurance (LMI), the price of which varies greatly depending on the lender, the level of risk and the interest rate charged.
If you decide to switch lenders, you’ll need to take into account additional costs, such as application and government fees. There may also be costs associated with closing your current loan product, especially if your home loan predates 1 July 2011, when exit fees were abolished.
To look at your options, consider speaking to a qualified professional (mortgage broker, accountant or financial adviser).