If you’ve already purchased your first property and have built up a considerable amount of equity you may be in an excellent position to buy an investment property.
Equity is how much of your home that you actually own, taking into consideration its current value and how much debt you have remaining on it. In many cases, you may be able to access some of this equity to help purchase a second property.
This can help you minimise the savings required for a deposit and streamline the loan process since you can use your current property as security on the new debt. There are several steps you must take before accessing your equity and deciding how much you have to use.
How to use equity to purchase an investment property
Calculate your equity
Equity is the difference between the current value of your property, and how much more you owe on it. For example, if the current value of your home is $500,000 and you still owe $200,000, your equity is $300,000.
To determine the current value of your home, you must consider more than just how much you originally paid for it. Inflation, changes to the housing market or your neighbourhood, and capital investment in the property can all affect the value of your home.
Looking at comparable sales in your area and working with a real estate agent to get a professional valuation will help you to get a better understanding of the current value of your property.
Banks will generally lend you up to 80% of the value of your home, minus the debt you owe. This is to ensure you don’t end up with a loan that’s larger than the value of your property if the value of your home decreases after you take out your equity.
So if your home is worth $500,000, 80% of its value is $400,000. If you still have $200,000 left to pay, that leaves you with $200,000 in usable equity.
In some cases, you may be able to borrow more than 80% if you have Lenders’ Mortgage Insurance, although this isn’t commonly recommended due to the associated risks.
When deciding how much to spend on your investment property, it’s recommended that you use the “rule of four”. That is, to multiply your usable equity by four and use that to determine the maximum amount you can pay for your investment property.
For an even clearer idea of how much you should spend on your investment property, there are several borrowing power calculators available to give you some more insight.
Research your loan options
Once you’ve figured out how much usable equity you have, it’s time to start researching your loan options. It’s recommended that you discuss your options with a financial advisor, who will be able to help you decide on what type of loan will be best suited to your financial situation.
If you take out a principal and interest home loan, you will be able to begin building equity in your investment property. This will put you in the best position to buy more investment properties down the road, especially if the value of your properties increases.
Your financial planner will also be able to assess your existing home loan, and compare it to different options from both your current lender and their competitors.
Uncover fees and costs involved
You’ll also need to make sure you’re aware of any fees and costs involved with using your equity to purchase an investment property.
This will all depend on your bank, how much equity you borrow and the value of the property you choose to buy. If you wish to access more than 80% of your usable equity, for example, you’ll have to pay for Lenders’ Mortgage Insurance.
If you choose to switch to another lender, there will also be various fees associated with that as well. You’ll want to be well aware of these to make sure that the savings you stand to make aren’t outweighed by the fees of changing lenders.
You’ll also need to consider what type of investment property you want to buy and the associated costs. If you want a long-term investment property that you will rent out, consider the costs that come with being a landlord and the continued maintenance involved.
If you plan on buying a development property that you will renovate and attempt to sell for a profit, make sure you can stick to a budget designed to ensure you don’t risk spending more than you can earn back at sale.
Apply for your loan
Once you’ve decided on a loan option with the help of your financial advisor, they will be there to do the paperwork and support you through the process. Once it’s been approved, you’re in the clear to go through real estate listings and find the perfect investment property for your circumstances and goals.
Investing in the property market for the first time can be a minefield, and mistakes can be made. It’s important to remember that even if you’ve built up a considerable amount of equity, that doesn’t always mean you’ll be able to borrow it. Your bank will take into account a variety of other factors, such as any other debts you have, your income, how many children you have and your age.
If you are able to access your equity, you may still want to avoid accessing as much of it as possible if you have no other spare funds. This way you won’t have to borrow money in an emergency and will still have something to fall back on. Trying to find cheap houses for sale for your first investment property may be a smart move and will minimise the risks involved.
You can discuss all of this with your financial adviser and make the smartest and safest decision possible for your circumstances.