Using equity to buy another house
Equity is one of the most useful tools property investors have at their disposal. When done correctly, using equity to acquire property can help you build your real estate portfolio faster and enjoy many benefits.
What is home equity?
Equity is the value of the property minus the money still owed. If your property’s value increases over time while you pay off your mortgage, its equity will continue to grow. However, if the value of the property decreases as time goes on, the equity could lessen.
There are many ways to build equity. A home's value may rise because of capital growth or dedicated mortgage payments. You could also increase the value in your home by making renovations.
How do I calculate my property’s equity?
You can calculate your home’s equity by taking the fair market value (or appraisal value) of the property and them subtracting that from the remaining principal amount (i.e., the outstanding balance) on your mortgage.
For instance, your house is valued at $600,000 and your mortgage has a balance of $250,000, the equity of your home would be $350,000.
The home equity formula would look like this:
Fair Market Value - (Remaining Principal Loan Amount + Other Liens) = Home Equity
An easier way to calculate equity is by using a home equity calculator. Simply input the needed information and you’ll have an estimate of your property’s equity. To get a more accurate number, it’s best to consult with a lender.
How can I use equity to buy a house?
You can use equity to buy a house through refinancing, line of credit, or cross collateralisation. Each option has its own benefits and drawbacks. Finding the right option involves reviewing your finances and your investment goals.
Access equity through refinancing
If you want to access equity to buy a second home, you can do so by refinancing your mortgage. The process works similar to the standard refinance and home purchase.
The equity from your home or investment property can be used as a deposit on a second property, while your current property becomes a security on the new debt. Using equity allows you to buy a second property with no cash deposit.
When you refinance your loan to access equity, the lender will calculate your loan to value ratio (LVR) to ensure some equity is held as security. Lenders will typically allow you to borrow up to 80% of the value of the property, minus outstanding debt, to purchase a second property. Some lenders will allow borrowing up to 90% of your property’s value with certain conditions, such as paying LMI.
Refinancing your current home to access equity is essentially increasing the debt on your current home loan, so this often means that you are taking the loan with a longer loan term than what’s left of your original loan.
Accessing your equity can increase how much you owe as well as the interest charged, which means your home loan repayments will likely increase.
Using line of credit or lump sum
A line of credit loan means a certain credit amount is approved based on your usable equity. You only pay interest on what you spend. You can apply for an equity release, but if you’re not ready to use the funds right now you can put it into an offset sub-account, so you won’t pay interest on the loan increase until you use the funds.
If you take out a lump sum, you'll pay interest on the entire amount. With a line of credit, you only pay interest on the amount used, but you could be tempted to access this money for unnecessary luxuries.
Cross collaterise to purchase a property
Cross-collaterisation involves using your existing property as collateral for a new loan. This method has its risk but can provide certain benefits under the right circumstances, such as minimised fees.
In cross-collaterisation, the equity of your current property is used as security for loans on both this property and another property. Essentially, your current property will be used as collateral for both your existing mortgage and the new one.
If you can't pay off the debt on one property, then both properties could be repossessed. There are some circumstances where cross collaterisation can be a good idea. For example, the debt on your current property might be too high to allow traditional refinancing.
If you will be able to pay off both mortgages and perhaps have good knowledge of the property market, then this could be an option.
Can I use equity to buy a house with no deposit?
Utilising the equity in your current property can allow you to buy that second property with no deposit by using a tactic called leveraging.
Leveraging is where you use the equity generated by the rising value of your existing property to purchase a new one. This strategy depends on the value of your existing property rising while the size of the mortgage either reduces or stays the same.
If you use the equity as a deposit on a second property, you will be paying off two home loans instead of one, so it’s important to ensure your cash flow will be able to handle this.
Pros and cons of using equity to buy a house
Just like with any investment strategy, there are advantages and disadvantages you need to be aware of. Using equity to purchase an investment property is possible, but you need to figure out if it’s the best option for you.
What are the advantages of using equity?
Many investors use equity in their existing properties to purchase more investment properties, which enables them to build a bigger investment portfolio.
It’s a common strategy for seasoned investors to use the equity in their current property to buy another investment property. This enables them to build a bigger investment portfolio. As a property grows in value, it allows the investor to buy another investment property, and so on.
By using existing equity to buy more properties, you can get into the market at today's prices and reap the rewards of price growth than if you had waited and saved the deposit, which can take years.
Over time, if you keep using this approach and adding even more properties to your investment portfolio, it will have a compounding effect: every time the property market rises, your property wealth and useable equity will rise too.
What are the risks of using equity?
As with any investment, it pays to be aware of the risks. If the property market falls, your wealth and useable equity falls too.
If you are buying a second property, you are not diversifying your assets—you are instead concentrating your wealth. If the property market drops, so will the value of your home. Of course, if the market works in your favour, you could do very well.
Consider how much knowledge you have of property investment in general, as well as of the particular market you are looking to buy into and consult a financial adviser if you're unsure.
It may also help in the long run if you have the cheapest investment home loan in the market. You’ll save more money by not paying too much interest. Take the time to research and compare home loan rates to find the best one for you.
Explore your mortgage options
As you can see, there are various ways to buy a property using equity. If you want to learn more about your finance options, it’s best to consult the professionals. Get in touch with the lending specialists at loans.com.au!
Call us at 13 10 90, and our friendly lending specialists will be more than happy to help you find a finance solution that fits your investment needs. You can also arrange a call at your earliest convenience, and we’ll reach out to you.
Find out in under 2 minutes if you qualify for one of our low rate home loans.
About the article
As Australia's leading online lender, loans.com.au has been helping people into their dream homes and cars for more than 10 years. Our content is written and reviewed by experienced financial experts. The information we provide is general in nature and does not take into account your personal objectives or needs. If you'd like to chat to one of our lending specialists about a home or car loan, contact us on Live Chat or by calling 13 10 90.
