How to use equity to buy an investment property
OK, so you are looking to invest in property? If you already own a property, it could be possible to use something called equity to assist in getting that next home loan, but there are also some potential risks to be aware of.
What is equity?
In short, it is the difference between the value of a property and the amount of any loan over that property.
For example, if a property is valued at $400,000, and that property has a mortgage with $100,000 left to pay on it (excluding interest and fees), then the amount of equity is $300,000.
How to borrow money for your investment property
When you apply to borrow money from a bank or other financial institution, they look at the LVR (loan to value ratio), or the percentage of the property's value the customer wants to borrow.
In the example above, the LVR is 25 per cent.
A bank will lend up to 80 per cent LVR on the value of your property, provided you can meet the repayments.
It is possible to borrow more than 80 per cent if you take out a lenders' mortgage insurance (LMI).
To really get an up to date snapshot of where you stand, get a valuation of your property.
The bank also analyses the ability of the borrower to pay back the debt, including by looking at income such as wages and rent.
Can you boost your equity?
There may be a few things you could consider to help increase your property's market value. Typically, these are by way of renovations or landscaping (adding value).
For example, I just purchased a three-bedroom, one-bathroom brick home with a pool and single lockup garage in the Sunshine Coast hinterlands for $320,000.
Using a pre-existing concrete slab, I was able to add value by building a one-bedroom granny flat. I also closed in the garage to the house to create a fourth bedroom and added a double carport out the front.
All of this cost $100,000, increased the potential rental income of the property by several hundred a week, and the property was revalued at $570,000.
The annual home loan repayments are $12,600. Not only do I have access to the equity of $150,000 to help me purchase another property, I also created a positive income of around $23,000 per annum, which I can use to pay down the mortgage.
Another way you may be able to increase your equity is to reduce the amount of debt on your property and pay it down as quickly as you can.
Having any investment income from the property going straight onto the home loan can be a great way to reduce the balance of the loan.
This could also reduce the interest payments over time.
You can also speak with your accountant about whether you could depreciate the property when it comes to tax time to help increase your financial return.
Using equity during the COVID-19 pandemic
Perhaps the biggest restriction the COVID-19 pandemic has created in the home loan market is in many banks' willingness to lend money, as the risk of properties declining in value is seen as higher than it was before.
A potential positive about buying in the current climate is that you may be able to purchase property at a lower price.
A downside about using your equity during COVID is that equity could quickly erode.
It is a good idea to consider the financial risks that this can involve, including whether your portfolio can sustain itself.
Some key considerations before purchasing an investment property
Make sure you have your finances in order.
Determine what your maximum price and minimum return is on a property.
For example, you could consider asking yourself:
● If I needed to drop the rent, could the rent still service the loan?
● When property is in high demand, what is the highest amount of rent I can achieve?
● If a tenant (commercial or residential) stops paying the rent or leaves at the end of their tenancy, can I afford to make the mortgage repayments while I wait for a new tenant to be found?
Know how you will service the loan if things go pear-shaped and know your numbers before you buy.