As any first home buyer will probably tell you, saving for a property deposit is no easy task – likely taking years of scrimping. But if you are already on the ladder, having little to no deposit doesn’t necessarily mean you should put your property investment dreams on ice.
That’s because it’s perfectly possible to buy a second property without putting any of your own cash into the deal, thanks to something known as equity.
Equity refers to the portion of your home that you actually own. This is worked out by subtracting the amount you own on its mortgage from its market value.
Let’s imagine your home is valued at $700,000 and you have a $300,000 loan outstanding. In this case, your equity would be $400,000 ($700,000 – $300,000 = $400,000).
Home equity naturally builds up over time as you pay down your mortgage. Market forces can also increase your equity by raising the value of your home.
The great thing is that you can leverage or borrow against this equity to buy a rental property. However, to manage their risk, many lenders only let you borrow up to 80% of the value of your home (less the debt you have secured against it).
This means you can’t access all of the equity you have in your home.
With this in mind, here’s how to work out your usable equity:
- Calculate 80% of the value of your home (in the above example, this would be $700,000 x 0.80 = $560,000)
- Subtract your outstanding mortgage ($560,000 – $300,000 = $260,000)
In theory, this gives you $260,000 of available equity to use as a deposit on an investment property and your associated costs – although that amount would differ from lender to lender.
Refinancing your home loan is one of the most popular ways of accessing home equity. That said, if you use this equity as a deposit for an investment property, you’ll be using more than one property as security for a mortgage.
This is known as ‘cross-collaterisation’. As with most things in life, cross-collaterisation comes with both pros and cons.
On the plus side, it can allow you to borrow more money. However, this can come at the expense of your flexibility as some actions you take on one property (such as selling it) can impact the other.
Cross-collaterisation isn’t the only thing you should consider before using equity from your home to buy an investment property.
You’re taking on more debt, which means you’ll be taking on more risk. As such, it’s strongly recommended you crunch the numbers to make sure you’re not overextending yourself. As always, it’s a good idea to always include a buffer when you do the sums to give yourself some financial breathing room.
Thinking of buying an investment property? Our Well Money investment home loan is an award-winning product that’s designed to be flexible. Click here to find out in just 60 seconds whether you qualify or call us on 1300 899 724.