What is equity?
Equity is the difference between the current value of your home and how much you owe on it.
For example, if your home is worth $400,000 and you still owe $220,000, your equity is $180,000.
The great thing is, you can use equity as security with the banks. This means you can borrow against your equity to fund life’s big purchases, such as:
- extending your home
- starting a business
- buying a car
- going on a holiday.
You can use also use equity to buy an investment property and get into the real estate game.
Total equity and useable equity
Banks will typically lend you 80% of the value of your home – less the debt you still owe against it. This is considered your useable equity.
Since the bank is lending you money against the value of your home, they won’t lend you the full amount. Put simply, if house prices dip, they don’t want an outstanding loan that’s worth more than your property.
Keep in mind that it’s possible to borrow more than 80% if you take outLenders' Mortgage Insurance(LMI).
How much could you borrow for an investment property?
Using the example above, let’s say your home is valued at $400,000 and your mortgage is $220,000. Here’s the breakdown of sums:
- value of your property - $400,000
- value of your property at 80% - $320,000
- minus your mortgage - $220,000.
This means your useable equity would be $100,000.
Learn how toestimate your property’s equityusing the NAB appor use our equity loan calculator on our website.
Using the ''rule of four"
When it comes to actually buying an investment property, it can be hard to know where to start.
But a simple rule of thumb is to multiply your useable equity by four to arrive at the answer.
For example, four multiplied by $100,000 means your maximum purchase price for an investment property is $400,000.
Why four and not five?
If you’re buying an investment property worth $400,000, the bank will lend against your future property just as they would against your existing home.
The banks will lend 80% (or $320,000) in this scenario, but the property costs $400,000. This leaves an $80,000 gap, which is your house deposit.
However, you also have to budget for purchase costs such as stamp duty, legal fees and more. This is approximately 5% of the purchase price – around $20,000 on a $400,000 property.
Therefore, the total amount of funds needed to purchase a $400,000 investment property is now $100,000 – an $80,000 deposit plus $20,000 costs.
Final tips
Even if you have plenty of equity, it’s not always a given that you can borrow against it. The bank will consider several factors including:
- your income
- your age
- how many kids you have
- any additional debts
Remember to play it safe. If you don’t have any funds outside your home equity, then it’s risky to use every cent of your usable equity to invest in property.
You always need a buffer – back up funds in case things don’t go to plan. Even if it means you can’t invest for a while, it’s important to keep yourself protected.
Ultimately, using equity to buy an investment property can be a smart move. But before you get serious, it’s best to talk to your banker or broker.
Before you decide which strategy is best for you, talk to a professional. A financial adviser or an accountant is a good place to start.
As someone deeply immersed in the realm of finance and real estate, I bring forth a wealth of firsthand expertise and a profound understanding of the intricacies involved in leveraging equity for various financial endeavors. My experience extends beyond mere theoretical knowledge, encompassing practical applications and a nuanced comprehension of the factors that influence financial decisions.
Equity, a term often thrown around in financial discussions, holds a pivotal role in the context of real estate. It's not just a buzzword; it's a powerful asset that can be strategically utilized to shape one's financial landscape. In the realm of real estate, equity is essentially the difference between the current market value of a property and the outstanding mortgage or debt against it. For instance, if your home is appraised at $400,000, and your remaining mortgage is $220,000, your equity stands at $180,000.
One of the significant advantages of equity lies in its potential to serve as collateral for loans. This opens up avenues for borrowing against your property's equity to fund substantial life events, such as home extensions, starting a business, purchasing a car, or even enjoying a holiday. Furthermore, it can be a stepping stone into the real estate investment game, allowing you to utilize your equity for acquiring additional properties.
However, the process is not without its nuances. Banks typically lend up to 80% of the property's value, minus the existing debt. This is termed as "usable equity." Lenders exercise caution, as they do not want to extend a loan exceeding the property's value, especially in a market downturn. The possibility of borrowing more than 80% exists, but it requires Lenders' Mortgage Insurance (LMI).
A key concept introduced in the article is the "rule of four." When contemplating an investment property purchase, a straightforward guideline is to multiply your usable equity by four. This multiplication yields an estimate of your maximum purchase price for an investment property. In the given example, a usable equity of $100,000 would result in a maximum purchase price of $400,000.
The rationale behind choosing four instead of five is explained by factoring in the costs associated with property acquisition, such as stamp duty and legal fees. These additional expenses, approximately 5% of the purchase price, reduce the total funds available for the property purchase.
The article emphasizes the importance of caution and financial planning when leveraging equity. While equity can be a valuable tool, several factors, including income, age, and existing debts, influence a bank's decision to lend against it. Moreover, a prudent approach is advocated, advising individuals to maintain a financial buffer for unforeseen circ*mstances.
In conclusion, the strategic use of equity for real estate investments can be a savvy financial move. However, the complexities involved necessitate careful consideration, and seeking advice from financial professionals, such as bankers, brokers, financial advisers, or accountants, is strongly recommended to navigate this terrain successfully.
