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If you already own your own home, you might not need a deposit to buy an investment property. Instead, you may be able to harness the power of your home equity.
Your home equity is the difference between your property’s market value and the balance of your mortgage. If you’ve owned your home for a few years, there’s a good chance you’ve built up some reasonable equity, and this can be a valuable resource when it comes to property investment.
Your local Mortgage Choice broker can help you to find out how much equity you have in your home, and how you might be able to use it to own an investment property sooner.
Here’s how it works. Let’s say you want to buy an investment property with a market value of $400,000. There are also additional purchase costs (legal fees, stamp duty and so on) of $20,000, bringing the total cost to $420,000.
Assuming that you meet the loan approval requirements, a lender will fund 80% of the property’s market value - potentially more if you're prepared to pay Lenders Mortgage Insurance (LMI). That is, the bank will lend you $320,000 to buy the investment property. As the total cost of the property is $420,000 you still need an additional $100,000 for the deposit and other upfront expenses. This can come from the equity in your existing home.
Let's say the market value of your existing home is $500,000 and the balance of your mortgage is $300,000. The difference between the two is $200,000, which is your home equity.
As an investor you can access up to 80% of your home equity (without the need to take out LMI), which equates to $160,000 in this example. Instead of coming up with a cash deposit for the additional $100,000 needed to buy the investment property, you can take this from the $160,000 of accessible equity in your existing home.
The available equity in your home is calculated at 80% of your home (without the need to take out LMI) less any current loans, which equates to $400,000 less $300,000 = $100,000.
Alternatively some lenders will lend up to 95% of the property value less the existing mortgage, where LMI would be paid on the amount borrowed over 80%.
Many property investment gurus say it’s important to repay the loan on your home as soon as you can. The equity that is drawn down from your home to purchase an investment is tax effective, but any remaining debt on your home isn’t. Therefore the loan on your home costs you much more on an ongoing basis than the loan on your investment property.
The property that you live in is not the only source of home equity. You can also use the equity in an existing investment property to help fund the purchase of another investment property.
Your Mortgage Choice broker can help you to work out how much equity you have in your property and how it can be accessed to fund your investment.
Work out the amount of equity available in your property using the estimated market value of your home – commonly based on comparable sales within your area or a real estate agent valuation, less the balance of your current loans secured by the property.
Work out how much money is required to achieve your plans. You may or may not want to – or be able to – access the full amount of equity that’s available, and your servicing capability is an important factor in this discussion. That is, your ability to service any additional repayments may have an impact on the amount of equity that you can access. Say, for example, that you have $150,000 worth of equity in your property. However, the amount of additional repayments you can afford based on your income and expenses works out to be $50,000; then realistically that’s the amount you would proceed to unlock, rather than the full $150,000 that’s available.
At this point of the process, you may want to start researching and assessing your home loan options. This is also a good opportunity do a “health check” on your current home loan, comparing it based on factors such as interest rates, fees and features against other offerings either by your current lender or other lenders in the market.
The product you choose and the amount of equity you can and want to access may result in various fees and costs. For example, if you choose to access over 80% of your property's value, you will likely need to pay Lenders' Mortgage Insurance (LMI). If you decide to switch to another lender, there may be associated fees with breaking from a fixed rate product or new loan application fee, government fees etc.
Once you've decided on a loan option, the next step is to contact the lender of your choice to get the process started.
Bear in mind that if you have not spoken to the lender up to this point, their assessment may differ from your estimates, i.e. you may be able to access more or less of what you've anticipated.
The above information is provided for general education purposes only and does not constitute specialist advice. It should not be relied upon for the purposes of entering into any legal or financial commitments. Specific investment advice should be obtained from a suitably qualified professional before adopting any investment strategy.