14 Nov Using the Equity in Your Home to Invest in Property
Many people who come to us to learn more about how to invest in real estate think that buying an investment property is beyond their reach, often because they currently have too much credit card or personal debt, and they want to wait until these debts are cleared before they get into property investing.
However, our approach is that, given certain conditions, personal debt need not be a barrier to growing a property portfolio. This is because one of the most cost-effective ways of investing in property is through using the home equity you have built up to finance the purchase of an investment property.
What is home equity and how can I use it for smart property investment?
Equity is the term applied to the difference between the amount your home is currently valued at, and the amount remaining to be paid off. For example, if your house is currently valued at $500,000 and you have $200,000 outstanding on your mortgage, the equity in your home is calculated as being $300,000.
Provided you have paid off at least 20% of your current mortgage, a proportion of the equity you have accrued (usually 80%) can then be used to obtain finance for the purchase of an investment property. If you have sufficient equity, plus some cash in reserve to cover any unexpected rent shortfalls or costs, this can mean that in practice it actually costs you very little to get started with property investment in Australia.
Building your home equity
If you are looking ahead and planning to buy an investment property, but currently don’t have sufficient equity in your home, there are some practical steps that you can take that will help to grow your home equity so that you have access to finance for real estate investing.
For instance, you could make extra repayments whenever possible on your mortgage, or alternatively increase the size of your regular monthly repayments. Switching lenders so that you have a lower monthly repayment, but at the same time continuing to make repayments at your current rate, can also lower the outstanding balance more quickly and grow your equity.
In addition, you might consider attaching an offset account to your mortgage account, as this can help to reduce the amount of interest you pay on your home loan, meaning that you bring down the principle at a faster rate.
What is Lenders Mortgage Insurance (LMI)?
Even if you think you don’t have sufficient equity in your home to fund an investment in property, it may still be possible through adding Lenders Mortgage Insurance (LMI) to your loan.
LMI is a sum that can be added to your loan if you don’t have a sufficient deposit to buy an investment property (which will usually be 20%). For instance, you may be looking to buy an investment property for $400,000, which would usually require a deposit of $80,000 (20%), However, if you only have $40,000 of equity in your home, you may nevertheless be able to take advantage of Lenders Mortgage Insurance in order to borrow the full $360,000 required (provided your income is sufficient to be able to service the loan).
While for some people the idea of paying LMI is off putting, it shouldn’t automatically be seen as a barrier to entering the investment market. This is because Lenders Mortgage Insurance may be the means of enabling you to invest in property sooner, and as has been well established, the length of time you hold an investment property is the key to growing your investment.
We can advise you on your LMI options, and advise you as to whether it is worthwhile course for you to take, given your particular circumstances and needs.
What are the benefits of using home equity to invest in property?
There are a number of benefits to be gained from investing in property in Australia, most of which can be enjoyed by using the equity in your home, even if you have a relatively modest income combined with some outstanding debt, such as credit cards or personal loans.
However, before you begin it is important to determine your goals as to whether you are intending your investment property to be cash positive, i.e., generate income each month over and above the costs associated with holding the property, or whether your aim is to achieve long term capital growth through a negatively geared property investment.
Buying a positive cash flow investment property
With a positive cash flow investment property (you might also see the terms positive income property or positively geared property used), the rental income you derive is greater than the associated holding costs.
This means that after all of the loan and interest repayments have been met, plus the other costs like property taxes, repairs, maintenance, etc., the rent paid still delivers cash into your account at the end of each month. This sort of investment gives you immediate returns, which you can then use either to pay off the mortgage more quickly, or to grow your property portfolio through further investments.
However, it is also important to note that any income derived from the property (after expenses) will be subject to tax.
Buying a negatively geared investment property
Negative gearing means that the expenses associated with owning and maintaining your investment property are greater than the amount of rent you receive, i.e., it costs you money each month.
There are a number of reasons why a negatively geared property may be a good strategy for investing in property, especially if the longer term growth of capital is your aim.
For instance, once your net rental losses each month after costs (including depreciation) have been accounted for, you can claim a tax deduction, e.g., if the amount of rent you receive is, over the course of the year, $10,000 less than the holding costs of the property, then your overall tax liability is reduced by this amount.
There is also the added feature that most negatively geared properties do, in time, become cash positive, while any losses that are accrued initially may well be made up for as your investment property increases in value over time.
What sort of home equity property investment strategy is right for me?
If you are unsure about how best to use the equity in your home to purchase an investment property, or what sort of real estate investing strategy is right for you, then talk to us.
At Power of Property, our role is to help you to achieve your property investment goals through understanding what it is you want to achieve, and then devising the most effective way of delivering on this. We have extensive knowledge of the investment loan market, and we work with a trusted team of experts who will guide you at every step of the way to ensure that you have the right financial and loan arrangements in place to make the most of your home equity.
To talk through the range of investment loan options open to you, or to find out more about how to invest in real estate, please call Michael Lawton on 0407 785 560 or Danielle Charlton on 0411 268 795, or book an online property strategy session at a time that suits you.