[Video] How To Use Your Equity To Buy Investment Property

What Is Equity?

Equity refers to the difference between your home’s current value and the outstanding amount you owe the bank. This is the amount you own outright of the property. However,  lenders typically limit your borrowing to 80% of the property value to avoid requiring your to pay Lenders Mortgage Insurance (LMI).

NOTE: LMI protects the lender in the event that the borrower defaults on their home loan and there is a “shortfall”. A shortfall occurs when the proceeds from the sale of the borrower’s property are smaller than the loan amount to be repaid. The LMI provider will recover the shortfall amount to the lender but the LMI provider may seek to recover the shortfall amount from the borrower.

An Example

The concept of equity can be best explained using a worked example.

Let us pretend you own your own home which is valued at $500,000. You owe $300,000 on this home so your equity is $200,000 ($500,000 value – the $300,000 loan). But, we can not draw the full $200,000 out without having to pay LMI.

The available equity without incurring LMI is $100,000 (80% of the $500,000 valuation – the $300,000 loan).

This amount can be utilised for the deposit and transaction costs of a new investment property.

We will restructure the current home loan to draw out this available equity. The loan structure for the new arrangement involves two components:

• Loan #1 – Existing home loan of $300,000 for owner-occupied purposes for your existing home. This is not tax deductible
• Loan #2 – New investment loan of $100,000 for investment purposes. This will cover the deposit on a new property, plus cover the transaction costs. This is tax deductible

Going beyond 80% Loan to Value Ratio (LVR) may be possible with LVRs of up to 88% being attainable, but this will attract higher interest rates and other costs.

How Much Do I Need To Borrow To Buy The New Investment Property?

To determine the additional loan needed for a new investment property, you typically need to have a 20% deposit and 5% to cover costs in most property transactions.

For a $400,000 property, the new loan secured against it would be $320,000, funded by the $100,000 equity released in Loan #2. This amount will finance the $80,000 deposit plus $20,000 in stamp duty and other transaction costs.

How Much Is My Property Worth?

A bank valuation can determine your property’s value. This is a straight forward process that can be triggered on your behalf by your Broker.

How Much Can I Borrow?

While having substantial equity in your home is beneficial, your income (including a percentage of the investment property’s projected rent) must support the repayment of all loans, including the new equity released in Loan #2.

Your Broker will help you to calculate your borrowing capacity and work out how much equity you can release in order to help you buy a new investment property.