Your home has increased in value.
You’ve also been paying the mortgage down for years, so the difference between what the property may be worth and what you owe has grown.
On paper, you have equity.
That can lead to the obvious question:
Can I use that equity to buy an investment property?
Potentially, yes. Equity in an existing property can sometimes form part of the funding strategy for another property purchase.
But having equity and being able to borrow enough to purchase an investment property are not the same thing.
For homeowners around Lake Macquarie considering their first or next investment property, there are really two questions to answer.
How much usable equity might be available?
And:
Can you service the total lending after the new property is purchased?
You need both sides of the equation.
What Is Property Equity?
At its simplest, equity is the difference between a property’s value and the debt secured against it.
Imagine your home is worth $900,000 and you owe $450,000.
On those figures, you have $450,000 of equity.
But that doesn’t necessarily mean a lender will allow you to withdraw $450,000 and use it elsewhere.
Lenders generally have limits around how much they’re prepared to lend relative to a property’s value.
That brings us to usable equity.
Usable Equity Is Different From Total Equity
Suppose your home is worth $900,000 and your mortgage is $450,000.
If a lender were comfortable with total lending up to 80% of the property’s value, that would represent $720,000.
Subtract the existing $450,000 mortgage and, as a simplified example, there could potentially be around $270,000 between the existing debt and that lending level.
That doesn’t mean you automatically qualify to borrow another $270,000.
The lender still needs to assess your income, expenses, liabilities, credit position and overall application.
The property value also needs to be acceptable to the lender.
But the calculation demonstrates why total equity and potentially usable equity aren’t the same number.
Why Do Investors Use Equity?
The most obvious reason is that it can reduce the amount of cash required from savings for another property purchase.
An investor may potentially use funds released against an existing property towards costs associated with acquiring another property.
That could include part or all of the required contribution and eligible purchasing costs, depending on the structure.
The remaining purchase price may then be financed against the investment property itself.
This can allow someone to invest without first saving the entire contribution in cash.
But using equity is still borrowing.
You are increasing debt.
Equity Isn’t Free Money
This is worth emphasising.
If you release $150,000 from your home to help purchase an investment property, your debt has increased by $150,000.
The fact that the money came from available property equity doesn’t make it savings.
There will generally be repayments and interest associated with the additional borrowing.
Before using equity, understand what the total debt position looks like after the investment purchase, not simply how much equity is currently available.
Borrowing Capacity Can Stop You Before Equity Does
This is where many potential investors get surprised.
Someone might own a property with substantial equity and assume another purchase should be straightforward.
Then the borrowing-capacity assessment says otherwise.
Lenders consider income, living expenses, existing debts, credit-card limits, dependants and other commitments when assessing an application.
They also assess existing and proposed lending using their applicable servicing methodology rather than simply looking at the repayment you’re currently making.
So you can have plenty of equity and still be unable to borrow the amount required for the next purchase.
Equity helps with the funding contribution. It doesn’t replace serviceability.
Rental Income Helps, but It Isn’t Necessarily Used Dollar for Dollar
The proposed investment property may generate rent.
That income can form part of a lender’s assessment, but lenders may not simply take 100% of the advertised weekly rent and treat every dollar as available income.
Assessment approaches vary.
A lender may make allowances for things such as vacancies or property-related costs when considering rental income.
If you’re working out borrowing capacity using:
“The property rents for $700 a week, so that’s another $36,400 of income”
your calculation may not match the lender’s.
Use the lender’s assessment rather than assuming the gross rent solves the servicing position.
What About Existing Investment Properties?
If you already own investment property, the picture becomes more complex.
There may be several property values, mortgages, rental incomes and expenses to consider.
Some properties may have substantial equity.
Others may be highly geared.
The objective isn’t necessarily to extract the maximum possible amount from whichever property has equity.
We need to understand the complete portfolio and what you’re trying to achieve next.
Keep the Loan Splits Clear
When equity is released for an investment purpose, loan structure becomes important.
Rather than simply increasing an existing home-loan balance and mixing different uses of borrowed money together, separate loan splits may make the purpose of each borrowing easier to identify.
For example, the existing home debt might remain in one split while funds being borrowed for an investment purpose are established separately.
This can also make the lending easier to understand and manage.
Tax deductibility depends on the use of borrowed funds and individual circumstances, not simply which property secures the loan.
Your accountant or registered tax adviser should advise you about tax consequences and the appropriate structure for your circumstances.
Be Careful With Cross-Collateralisation
Another decision is how the properties are used as security.
It may be possible for one lender to take security over multiple properties.
That can sometimes make a transaction straightforward, but it can also link the properties together.
For example, selling or refinancing one property later may require the lender to reassess the remaining security position before releasing it.
In other circumstances, borrowers may prefer loans and securities to remain more clearly separated.
There isn’t one structure that’s automatically correct.
But it’s worth understanding whether the lender will hold one property as security for one loan, or whether multiple properties are being tied together.
Don’t discover the security structure years later when you want to sell something.
Should You Use All the Equity Available?
Not necessarily.
Just because a lender may allow additional borrowing doesn’t mean you need to use all of it.
Retaining an equity buffer can provide flexibility.
Property values can move.
Your financial circumstances can change.
Another opportunity may arise later.
The right amount to release depends on the proposed purchase and broader strategy.
The objective is to fund what you need, not to borrow the maximum simply because the property has increased in value.
What If the Valuation Comes in Lower Than Expected?
This happens.
You might believe your home is worth $1 million based on recent local sales.
The lender’s valuation comes back at $920,000.
That lower figure can reduce the amount of usable equity available.
It may change the purchase budget, cash contribution or lending structure.
This is why I wouldn’t make an unconditional investment purchase based solely on your own estimate of the existing property’s value.
The lender needs to establish the value it will use for the application.
Your Credit Cards Can Affect Borrowing Capacity
A credit card with no balance can still matter.
Lenders may assess the available limit rather than simply today’s outstanding balance.
If you have several cards with substantial unused limits, they can potentially reduce borrowing capacity.
The same applies to other liabilities such as personal loans, car finance, buy-now-pay-later commitments and existing mortgages.
Don’t close facilities purely because you assume it will solve borrowing capacity without first understanding the overall position.
But make sure we know about all existing liabilities when we assess the proposed investment purchase.
What About Interest-Only Repayments?
Some property investors consider interest-only lending as part of their strategy.
Interest-only repayments can reduce the required repayment during the interest-only period because the borrower isn’t reducing principal during that time.
However, the debt doesn’t reduce through those scheduled repayments, and repayments can increase when the interest-only period ends.
Interest-only lending is also subject to lender criteria.
It should be considered in the context of your objectives, cashflow and overall strategy rather than simply as a way of producing the smallest immediate repayment.
Can You Use Equity for the Entire Deposit?
Potentially, depending on the available equity, borrowing capacity and lending structure.
For example, one facility may potentially release funds against an existing property while another loan finances the balance against the new investment property.
But there are purchasing costs to consider as well.
Stamp duty, conveyancing, inspections and other transaction costs can require significant funds.
The complete funding position needs to be calculated before deciding what property price you can pursue.
Don’t Forget the Investment Property Has Expenses
Rental income isn’t pure profit.
An investment property can involve:
council rates
insurance
property management
maintenance
strata levies where applicable
periods without a tenant
repairs
other ownership expenses
There can also be tax consequences.
Your accountant or tax adviser should help you understand the tax position and how the investment fits into your broader financial circumstances.
From a lending perspective, we want to make sure the proposed commitments are understood before the purchase occurs.
Should You Buy the Maximum Property You Can Finance?
Borrowing capacity provides a limit based on lender assessment.
It isn’t a target.
Suppose you’re assessed as potentially able to complete an $850,000 investment purchase.
That doesn’t mean an $850,000 property is automatically the right investment.
Property selection, investment strategy, expected return and risk are separate decisions.
A mortgage broker can help with the lending.
We aren’t choosing the investment property for you.
The finance should support the investment decision, not become the reason for making it.
What If You Want to Buy Again Later?
This is a very useful question to ask before the first investment purchase.
If your objective is to build a property portfolio, the structure of today’s transaction can affect tomorrow’s borrowing position.
Think beyond:
“Can I buy this property?”
Ask:
“What might my position look like after I buy it?”
The new debt, rental income, remaining equity and cashflow all become part of the next assessment.
That doesn’t mean we can guarantee future borrowing capacity. Lending criteria, interest rates, property values and personal circumstances can all change.
It means we shouldn’t ignore your longer-term objective when considering today’s structure.
Investment Property Finance Around Lake Macquarie
If you own a home around Lake Macquarie and are thinking about purchasing an investment property, start by understanding both sides of the equation.
How much usable equity may be available?
And what does your borrowing capacity look like after all existing and proposed commitments are considered?
Having one without the other may not get the purchase done.
Thinking About Using Your Equity?
Contact Thrive Broking with your approximate property value, current home-loan balance, income and the price range you’re considering for the investment property.
We can look at the lending position, estimate the equity that may potentially be available and investigate home-loan options for the proposed purchase.
Before you start looking for the next property, find out whether your equity and your borrowing capacity can actually work together to fund it.