If you’re in the property market game, you might already be thinking about building out your investment property portfolio. It’s a smart move, especially if you already own a property - this lowers your lending risk and helps you secure your next investment property with less cash upfront.
You might have also heard about something called equity and probably wondered how that factors into buying an investment property. The good news is that buying property with equity is easier than you might think, you just need to know how much of it is usable equity.
So, if you’re ready to expand your investment portfolio and snag that next investment property, keep reading to discover how to use home equity to buy a rental property and everything you need to know about buying property with equity.
What is equity?
Let’s run you through the basics first. In a nutshell, equity is the difference between your property’s value and how much you still have to pay off on your home loan. Still confused? Not to worry, it's always much easier to understand equity with a real-world example.
Let’s assume your current property is valued at $650,000 and you’ve got a $100,000 mortgage left to pay off. Your equity in this instance would work out to $550,000 (or, the difference between your property value and outstanding mortgage).
But how does equity work when buying an investment property? To put it simply, equity can be used as a deposit against your next property purchase, and it’s just one of the many benefits of using home equity to buy a rental property.
One of the biggest challenges to securing a second (or third) rental property is the high costs of saving up for a deposit. And as you can probably tell by now, equity can be a useful way to help overcome this when growing your property investment portfolio.
Before we get into exactly how to use equity to buy an investment property, it’s important you have the right loan structure set up on your existing property. With a principal and interest loan (rather than an interest-only loan), you can start building equity as soon as you start paying down your mortgage.
Soon you’ll have enough usable equity to harness and purchase the next property in your investment portfolio!
What are the benefits of buying property with equity?
Figuring out if buying property with equity is the right strategy can be confusing, especially if you’re not familiar with the process. But we’re here to tell you that there are lots of advantages to buying a property with equity, including:
- It’s a low-risk investment strategy: if you’re tapping into equity on your first investment property to fund your next rental property, this strategy is relatively low risk (as long as you’ve set yourself up with a buffer to cover any changes in interest rates or a drop in rent).
- It removes the need for a cash deposit: one of the biggest perks of buying a property with equity is ditching the need for a big cash deposit. As your property portfolio grows, the benefits of equity compound and enables you to easily grow your investments without having to save up the cash to fund each purchase.
- It speeds up the growth of your property portfolio: plus, ditching the need for a cash deposit allows you to grow your portfolio at a faster rate, too. This can enable you to build a balanced property portfolio in a much shorter timeframe than if you were to save for each deposit with your main source of income.
When it comes to using equity to buy another property?, the benefits are obvious. With less upfront cash needed, you can make your next investment purchase sooner than you would be able to do otherwise.
How does equity work when buying an investment property?
In understanding how to use equity to buy an investment property, it’s important to recognise the difference between equity and usable equity.
Unfortunately, most banks and lenders won’t let you use all of your home’s equity when applying for a new home loan. Typically, lenders use a formula called loan to value ratio (LVR) to work out what percentage of your home’s equity is usable.
While every bank is different and each loan comes with its own terms and conditions, most will lend up to 80% LVR on the value of your property (minus any debts you owe and fees like stamp duty).
Here’s a quick example to help you calculate your property’s usable equity and how to use equity to buy an investment property:
- Let’s say your property is valued at $650,000
- An 80% LVR for this property would be $520,000
- But, you also need to factor in the $100,000 you still owe on your mortgage
- That means an LVR of 80% (minus your debts owing) equals $420,000 of usable equity.
You may be able to borrow more than 80% if you’re happy to pay extra fees and charges such as Lenders Mortgage Insurance (LMI). It all depends on your investment goals and your objectives based on your financial situation.
Remember, it’s important to chat with a bank, lender or mortgage broker to figure out how much equity you can use to grow your property portfolio. Every bank is different and there can be other factors that may impact the equity you can tap into to grow your investment portfolio.
How to boost your property’s equity to grow your property portfolio
Now that you know how to use equity to buy an investment property, it might be worth considering this strategy to grow your investment portfolio. It makes sense, considering how equity can enable you to build a balanced portfolio at a faster rate than otherwise possible.
So, what can you do to boost your equity in a property?
- Boost the value of your property: by increasing your property’s market value with value-adding renovations, you can boost your equity to fund your next property purchase. Make sure to check which renovations add the most value to your property before investing in any major repairs or remodels.
- Reduce the amount you own on your property: lowering your debts (using things like offset accounts) is another effective way to boost your usable equity. This involves making extra mortgage repayments to lower your debts and increase your equity for future investment purchases.
The bottom line is that understanding how equity works and the steps you can take to increase your usable equity will help you grow a balanced portfolio sooner rather than later. Plus, there are simple steps you can take to increase your equity and expand your portfolio to reduce your risk and increase your returns as an investor.
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Disclaimer: The views, information, or opinions expressed in this blog post are for general information purposes only and should not be relied upon. We have not taken into account specific situations, facts or circumstances, and no part of this blog post constitutes personal financial, legal, or tax advice to you. You should seek tax advice from your accountant, specific to your situation.