Using equity to buy another property.
A popular way to buy a second property, including an investment property, is to use the equity on your existing home, meaning you don’t have to put any physical cash towards the deposit. Here’s how to use your available equity.
Home equity explained.
Quite simply, home equity is the difference between the value of your property and the outstanding debt on your home loan. For example, if your home is worth $500,000 and the current debt on your home loan is $320,000, then your equity is $180,000.
How to calculate your usable equity.
A common misconception is that you can use all your equity to buy a property. In most instances, you can only borrow up to 80% of the value of your home.
With this in mind, here’s how you can calculate your usable equity:
- Calculate 80% of the value of your home (for example: $500,000 x 80% = $400,000)
- Subtract your current outstanding debt ($400,000 - $320,000 = $80,000).
This means you’d have $80,000 of usable equity to put towards a deposit for a home loan, as well as other buying costs like stamp duty and settlement fees.
If the usable equity isn’t enough to cover the full deposit and any stamp duty and settlement costs, you’ll also have to make a cash contribution.
How to calculate your borrowing power.
In most instances, you need a 20% deposit for a home loan, including for a bridging loan or an investment home loan.
Therefore, if you used $80,000 worth of equity as a deposit, you could purchase a $400,000 property – assuming you cover stamp duty and settlement fees (including government fees) with money you’ve saved, and you meet the necessary criteria to get the loan.
It’s possible to buy a property with a deposit lower than 20%, but you’ll most likely have to take out Lenders’ Mortgage Insurance (LMI). This means you’ll probably have to pay an additional fee (approximately 2 to 3% of the loan amount), and your interest rates on the new loan may also be higher.
When it comes to your usable equity and borrowing power, a Home Lending Specialist can talk you through the possibilities.
Weighing up the pros and cons.
Using equity is a great option to potentially lock in a better interest rate and avoid paying LMI.
Keep in mind that the property you’re taking equity from will become additional security for your new loan – we call this cross-collateralisation. This means any decisions you make to one loan or property may impact the other.
For example, if you sell one property, the money from the sale may be used to reduce your other loan. It all depends on the value of the property you’re keeping and your remaining repayments.
Common questions.
There are a few things you could do:
- Make extra repayments on your existing home loan to decrease the amount you owe (if your loan conditions allow)
- Use an offset account (if you’re eligible) to save on interest and make your repayments go further
- Make renovations to your home to increase its value (since equity takes into account the market value of your home).
This depends on the purchase price of the property you want and the equity you already have – a Home Lending Specialist or broker will be able to give you specific advice based on your situation.
As a general rule, you should aim for a 20% deposit for your new property. Remember, your usable equity that you could put towards a deposit for a new property is 80% of the current value of your home, minus what you still owe on the loan. If that’s not enough, you’ll need a cash contribution to make up the 20% (plus fees).
It’s a detailed report of the property that outlines what a property is worth at a particular time, based on the specific construction and details of the property.