What is equity?
Equity is essentially the value of your home, minus what you still owe on it.
So if you have a home worth $500,000 and still owe $300,000 on the mortgage, your equity in that property is $200,000. If you’ve paid your home off, the usable equity in your home is simply what it’s currently worth on the property market.
There is a difference though between the equity you have and the ‘usable’ equity, as we explain below.
Using equity in your home to invest
Pulling equity out of your primary home to invest in another property is a strategy many people use to build their portfolio. There are several ways to do this.
A bank will typically lend you up to 80 percent of the value of your home (if you want to borrow more than that you’ll need to take out Lenders Mortgage Insurance (LMI).
Let’s go back to our sums above to work out how much usable equity you have access to.
- The market value of your home is $500,00
- Value of your property at 80% is $400,000
- You still owe $300,000 on the mortgage
- This means your useable equity is $100,000.
How much equity do you need to buy an investment property?
It’s one of those ‘how long is a piece of string’ questions! But there is a formula you can use to determine whether you have enough equity to buy an investment property.
It’s called the Rule of Four – and all you do is multiply the equity you currently have available to you by four. So if we use the example above and you have $100,000 of usable equity available, multiplying that by four gives us $400,000 – which is roughly the amount you should be able to borrow in order to invest.
However, you also need to factor in other costs such as legal and conveyancing fees, valuation fees, land tax and stamp duty (if applicable) which might cost you an additional $20,000. And if you find a property for $400,000 and the bank lends you 80 percent of the value of that property, you’ll be borrowing $320,000 – and using $80,000 of your equity as the deposit and $20,000 of your equity to put towards those additional costs of buying a property.
Where does this leave my primary home?
If you want to pull equity out of your current home, you may need to refinance your existing home loan and get a specific investment loan.
As a result, your existing mortgage is likely to increase and your monthly mortgage repayments may go up too. So it’s not quite as simple as simply taking out the equity that you’ve accrued – you’re still going to have to be able to cover your increased payments, and ensure that you can cover the payments on an investment property too (usually by renting it out).
Should I use my equity to invest?
It’s a really personal decision and considering your current financial circumstances and resources is important, as there are risks to any investment. The bank will also closely assess your income, current debts, age and other commitments before deciding whether to approve an investment loan.
Using equity to invest is one way to build your property portfolio, but it’s important to consider your situation and minimise risk as much as possible.
Extra considerations
While property investment can be a great option for some, investors should be prepared to face different challenges with their property over time. This could include finding tenants to help cover repayments, or the possibility of property value decreasing if the market shifts, which could leave you having to pay two mortgages – the one on your investment property and the elevated mortgage on your primary dwelling.
Using equity to help build your property portfolio is possible, but speak with a financial planner before making any decisions to ensure it will suit your financial situation.