When you have a principal & interest mortgage, every repayment you make slowly builds up equity in your home. You can tap into this equity to buy an investment property and even start building a property portfolio.
What is equity?
Equity is the difference between your home’s current market value and the amount still owing on your home loan.
To give you an example, imagine your home is valued at $800,000 and you owe $300,000 on your mortgage. Your equity is $500,000 ($800,000 minus $300,000).
Equity is created in two ways:
● Capital growth – if your home rises in value once you’ve purchased it, your equity also increases by the same amount
● Regular principal and interest repayments – as these decrease the amount you still owe on the property
One of the most common ways to access equity is by refinancing your existing mortgage. To do this, a lender will typically require a formal property valuation. You then refinance your mortgage based on the new value of your home. This then frees up some of the equity so it can be put towards a deposit on an investment property.
How much equity can you use?
Most lenders don’t allow you to use all the equity in your home. This is because the new loan could be worth more than the property if prices were to fall in the future. So, typically, they’ll lend you up to 80% of the value of your property – though this depends on your individual financial circumstances such as income, credit score and lifestyle.
As such, the amount of equity you can use in a property is 80% of the current value of your home less your current mortgage.
Using the previous example, your useable equity is calculated as follows:
● Current value = $800,000
● Value at 80% = $640,000
● Outstanding mortgage = $300,000
● Useable equity = $640,000 – $300,000 = $340,000
How much can you borrow?
As a general rule, you can borrow up to four times the amount of your useable equity on an investment property. This means your equity should cover your deposit, stamp duty, legal fees and other costs.
So, in the above scenario, you may be able to purchase an investment property with a maximum value of $1,360,000.
Of course, just because you can borrow up to that amount doesn’t mean you should. That’s because tapping into your home’s equity to buy an investment property does carry some risk.
Remember to play it safe
When you refinance your property to leverage equity, you often increase the amount of money you owe on your home loan. This, in turn, can increase your monthly repayments. On top of this, your investment property will also have a mortgage on it. If you don’t keep up with your repayments then you could end up losing your home, investment property or both.
As such, crunch your numbers beforehand to work out what you can afford. It’s a good idea to include a sufficient buffer fund in your calculations that ensures you can cover your expenses should things not go to plan.
Also, do your homework before you purchase any investment property. Property is a big financial commitment, so it’s essential to educate yourself before diving in.