How To Use Home Equity To Buy or Investment other Property?

How To Use Home Equity To Buy or Investment other Property?

This article writes to provide you with general information, about your loan, purchasing property and creating wealth. Our topic is using equity to purchase an investment property. This is a scenario that comes up frequently for me, I assist people to purchase their home and after a period of paying down their loan. A combination with capital growth they develop equity in their home. Many of these people want to know, how they can use that equity to purchase an investment property. Why you would use it? How to calculate and access it? And then we'll look at a couple of different scenarios. Is equity well in simple terms, equity is the difference between the market value of your property. The amount you still owe against the property.

How To Use Home Equity To Buy or Investment other Property
What is Equity

For example: - We have a property that is valued at $500,000. It currently has a loan against it of $300,000. The equity position in this example is $200,000 that's a very straightforward version.

Why Would You Access Equity?

There are many different reasons, why you want to access your equity? You may need to increase the size of your home or modernize it. Today home renovations often cost a lot and most people have not been able to save for this. They use the home equity built up in their property to fund this. You are may wish to take the holiday of a lifetime. You do not have enough savings to pay for it. 

It may be time to upgrade the family, car or purchase a major item for your home as part of your investment strategy. You may wish to start a managed fund or purchase a parcel of shares or you may wish to purchase an investment property to help fund. Your retirement using the home equity in your home can help to create or build your wealth by accessing other investments.

The Investment Property and Calculating Your Home Equity

In this investment article that we will focus on is the investment property and calculating your home equity, this is undoubtedly where most people get a little confused in terms of understanding. How much home equity they have and what part of that home equity they can access. Let's go back to our example.

How To Use Home Equity To Buy or Investment other Property
Calculating Your Home Equity

For example: - Where we have a property valued at $500,000 and you owe $300,000 you would like to access the equity in your property. If you access a $100,000 of home equity, then you'll take your total borrowings up to $400,000. This represents 80% of the total value of the property. This is important because at this point you would not have to pay any lenders mortgage insurance as your total borrowings. Don't exceed the 80% loan-to-value ratio you may have also heard this referred to as LVR. You can potentially access another $50,000 of your home equity. This would take your total borrowings above the 80% mark and you would then be charged lenders mortgage insurance and that's not only on the additional $50,000.

But on the total borrowings of $450,000, this can become very costly there are times. When people do this and this is generally because the return from the potential investment outweighs the LMI costs.

How To Use Home Equity To Buy or Investment other Property

How Do We Access Equity?

The next part is where most people make a mistake the remaining $50,000 in home equity can really only be accessed. When you sell the property in the past some lenders would allow you to borrow up to 100% of the value of your property. The current climate the majority of lenders will cap your borrowings at 90% of the property's value. How do we access equity? Essentially there are two ways to access your home equity. First is through a lump sum payout and the second is through a drawdown or an equity facility. Let's look at these two different options.

Lump Sum Payout or Drawdown

As a lump sum payout or drawdown, you would increase your current loan. And in this case, it is by a $100,000 you would then have the funds deposited into an account or drawn in the form of a check payable. The funds needed to be transferred.

For example: - Where you're purchasing a block of land. Let's say for a $100,000, you would have the bank draw a check to the vendor for the $100,000 and you would pass that check across at settlement. But let's say you didn't need to use all of the money at once. You wanted to draw down the funds as you needed them. In this case, you would establish an equity or drawdown facility. The facility would have a limit and in this case, it's $100,000, you would access the funds as you need it. And only pay interest on the funds as you use them as opposed to the lump sum payout option. Where you start paying interest on the funds as soon as they are paid out to the loan?

This option works really well in circumstances such as renovations. We only need to pay the Builder as work is completed or someone, who may wish to invest in a share portfolio. And does not require all of their capital at once rather they require the funds as opportunities present themselves.

What Are The Lender Requirements, When You Want To Access Your Equity?

The first thing that they will require from you is an application your lender will conduct a valuation of your property to determine. Its value and you will need to demonstrate that you can afford to repay. The new loan in your application you would need to disclose the purpose of the additional funds. And the lender may then require further documentation in relation.

For example: - If you are accessing equity to pay for renovations. Then the lender may request builder’s quotes or a fixed price building contract. If you are accessing equity for investment into shares or manage funds, then the lender may require seeing a copy of your financial planner’s statement of advice. If you wanted to buy a car, using your equity, then the lender may wish to see a copy of the sales advice from the car dealer. If you are accessing equity to purchase an investment property, then the lender may require seeing a copy of an exchange contract on the new property, before releasing the funds.

When Do You Need To Access Equity?

If you're thinking of using the equity in your property for renovations or investments, then before you start knocking down walls buying shares or making offers on a property. You need to have your equity facility set up to speak to your broker at the very beginning. Let's look at a couple of different scenarios. The outcomes in these scenarios are exactly the same. How are there two different ways of structuring this? And we'll go through the pros and cons of both.

First Scenario

In this first scenario, we have your property valued at $500,000 and you have $300,000 on borrowings against it. You would like to purchase an investment property for $400,000. There are costs associated with the purchase such as stamp duty, solicitors fees, etc. The total cost to purchase this property is approximately $415,000 because you have sufficient equity in your home. This scenario the lender will actually fund the full purchase price of the investment property, plus the additional costs. When you add the two property values together, you have a total security value of $900,000. And by adding the two loan amounts together, you have $715,000 worth of debt. As an overall percentage, your total borrowings equal 79.50%. This one this is under the 80%, LMI threshold and no mortgage insurance would be payable. This all seems easy and often.

In this second scenario, you need to be aware that both properties will be tied together, or cross-collateralized. This means that the lender secures both properties against the total debt. And this can cause potential restrictions. If you decide, you wanted to refinance one of the properties to another lender in the future or it could limit your options if you want to sell one of the properties.

For example: - If you sold your home for $500,000. You would have to pay down the debt against the investment property. And to what level would be dictated by the lender in this second scenario the outcome is the same, the structure is different. You have a property and your property is worth $500,000 with a loan of $300,000 against them. We set up an equity facility or a drawdown facility for $100,000, and that is with the same lender. When you purchase an investment property for $400,000 and we use $95,000 from the equity loan to cover your 20% deposit, plus the associated costs. Then we set up another loan with a different lender. That represents 80% of the purchase price. Our total security value is $900,000. And our total debt level is $715,000 that’s representing our 79.5% loan-to-value ratio. You can see our n numbers are exactly the same.

We have added two further steps the reason for this is to give your home, some protection against any possible problems with the investment property.

For example:-  Your tenants stopped paying your rent and you cannot afford to repay the $320,000 loan by yourself. If that $320,000 investment loan falls into default, and lender B is then forced to foreclose on the investment property.

This is the worst case scenario. Under this structure then 2 B does not hold the title deeds to your home. And therefore does not have the power to sell your home. If there is a potential shortfall, we refer to this as spreading your risk across lenders or not putting all your eggs in one basket. Accessing equity to invest should always be part of a well-thought-out plan and you should consult with your financial adviser or accountant, before speaking with your broker.

I hope you've enjoyed this article. Our aim is to keep this article short, and to the point. That you can refer back to these in the future, and also pass them on to your friends. If you feel this information would help them.

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