couple buying a home

Use the equity in your home to buy another home

You might have your eye set on an investment property, a place for the kids or a holiday home. If you're thinking about how to finance a second property, did you know you can unlock your existing home equity to do so?

The equity in an asset is its value, less any money owed on it.

For example, if your house is valued at $600,000 and the current debt is $250,000, the equity in the home would be $350,000.

Utilise your equity

Accessing the equity in your loan is easy. With a simple mortgage refinance, you can be steps closer to owning another home. This equity can then be used as a deposit on a second property, while your current home becomes a security on the new debt.

When the value of your home rises, the equity does too. 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 (though you will need to consider the costs of materials and labour to do this).

How much can I borrow?

Your lender will calculate your loan to value ratio (LVR) to ensure some equity is held as security. After this, you can determine how much equity you have after refinancing.

Consider the earlier example, where the equity is $350,000.

If your lender offers an 80 per cent LVR - note than anything higher than this will likely require Lenders Mortgage Insurance - you have $280,000 usable equity. This amount can be used for a home mortgage for another property. Keep in mind that you'll need more than the deposit - stamp duty and legal fees will have to be factored in.

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 link your line of credit loan to an offset account, too. This offsets the credit amount in the offset account against interest payable on the loan.

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.

Should you cross collaterise?

According to Your Investment Property Magazine's 'Beginner's Guide To Accessing Equity From Property', cross collaterisation is a high risk strategy.

The equity of your current property is used as security for loans on both this property and another property. So if you can't pay off the debt on one property, then both properties could be repossessed.

However, there are some cases that permit cross collaterisation. 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 - but be aware of the risks.

Risks

As with any investment, it pays to be aware of the risks.

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.

Image credit: pallspera.com

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This information has been prepared without taking into account your individual objectives, financial situation or needs. You should, before acting on this information, consider its appropriateness to your circumstances.

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