How To Use Home Equity To Buy or Investment other Property?
This article writes to provide you
with general information, about your loan, purchasing property and creating
wealth. Our topic is using equity to
purchase an investment property. This is a scenario that comes up frequently
for me, I assist people to purchase their home and after a period of paying
down their loan. A
combination with capital growth they develop equity in their home. Many of these people want to know, how
they can use that equity to purchase an investment property. Why you would use
it? How to calculate and access it? And then we'll look at a couple of
different scenarios. Is equity well
in simple terms, equity is
the difference between the market value of your property. The amount you still
owe against the property.
For example: - We
have a property that is valued at $500,000. It currently has a loan against it
of $300,000. The equity position in
this example is $200,000 that's a very straightforward version.
Why
Would You Access Equity?
There are many different reasons,
why you want to access your equity?
You may need to increase the size of your home or modernize it. Today home
renovations often cost a lot and most people have not been able to save for
this. They use the home equity built
up in their property to fund this. You are may wish to take the holiday of a
lifetime. You do not have enough savings to pay for it.
It may be time to upgrade the family, car or purchase a major item for your
home as part of your investment strategy. You may wish to start a managed fund
or purchase a parcel of shares or you may wish to purchase an investment
property to help fund. Your retirement using the home equity in your home can help to create or build your
wealth by accessing other investments.
The
Investment Property and Calculating Your Home Equity
In this investment article that we
will focus on is the investment property and calculating your home equity, this is undoubtedly where
most people get a little confused in terms of understanding. How much home equity they have and what
part of that home equity they
can access. Let's go back to our example.
For example: -
Where we have a property valued at $500,000 and you owe $300,000 you would like
to access the equity in
your property. If you access a $100,000 of home equity, then you'll take your
total borrowings up to $400,000. This represents 80% of the total value of the
property. This is important because at this point you would not have to pay any
lenders mortgage insurance as
your total borrowings. Don't exceed the 80% loan-to-value ratio you may have
also heard this referred to as LVR. You can potentially access another $50,000
of your home equity. This
would take your total borrowings above the 80% mark and you would then be
charged lenders mortgage insurance and
that's not only on the additional $50,000.
But on the total borrowings of
$450,000, this can become very costly there are times. When people do this and
this is generally because the return from the potential investment outweighs
the LMI costs.
How Do
We Access Equity?
The next part is where most people
make a mistake the remaining $50,000 in home equity can really only be accessed. When you sell the
property in the past some lenders would allow you to borrow up to 100% of the
value of your property. The current climate the majority of lenders will cap
your borrowings at 90% of the property's value. How do we access equity? Essentially there are
two ways to access your home
equity. First is through a lump sum payout and the second is
through a drawdown or an equity facility. Let's look at these two different
options.
Lump Sum
Payout or Drawdown
As a lump sum payout or drawdown,
you would increase your current loan. And in this case, it is by a $100,000 you
would then have the funds deposited into an account or drawn in the form of a
check payable. The funds needed to be transferred.
For example: - Where
you're purchasing a block of land. Let's say for a $100,000, you would have the
bank draw a check to the vendor for the $100,000 and you would pass that check
across at settlement. But let's say you didn't need to use all of the money at
once. You wanted to draw down the funds as you needed them. In this case, you
would establish an equity or
drawdown facility. The facility would have a limit and in this case, it's
$100,000, you would access the funds as you need it. And only pay interest on
the funds as you use them as opposed to the lump sum payout option. Where you
start paying interest on the funds as soon as they are paid out to the loan?
This option works really well in
circumstances such as renovations. We only need to pay the Builder as work is
completed or someone, who may wish to invest in a share portfolio. And does not
require all of their capital at once rather they require the funds as
opportunities present themselves.
What Are
The Lender Requirements, When You Want To Access Your Equity?
The first thing that they will
require from you is an application your lender will conduct a valuation of your
property to determine. Its value and you will need to demonstrate that you can
afford to repay. The new loan in
your application you would need to disclose the purpose of the additional
funds. And the lender may then require further documentation in relation.
For example: - If
you are accessing equity to
pay for renovations. Then the lender may request builder’s quotes or a fixed
price building contract. If you are accessing equity for investment into shares or manage funds,
then the lender may require seeing a copy of your financial planner’s statement
of advice. If you wanted to buy a car, using your equity, then the lender may
wish to see a copy of the sales advice from the car dealer. If you are
accessing equity to
purchase an investment property,
then the lender may require seeing a copy of an exchange contract on the new
property, before releasing the funds.
When Do
You Need To Access Equity?
If you're thinking of using
the equity in your
property for renovations or investments, then before you start knocking down
walls buying shares or making offers on a property. You need to have your equity facility set up to speak
to your broker at the very beginning. Let's look at a couple of different
scenarios. The outcomes in these scenarios are exactly the same. How are there
two different ways of structuring this? And we'll go through the pros and cons
of both.
In this first scenario, we have
your property valued at $500,000 and you have $300,000 on borrowings against
it. You would like to purchase an investment
property for $400,000. There are costs associated with the purchase
such as stamp duty, solicitors fees, etc. The total cost to purchase this
property is approximately $415,000 because you have sufficient equity in your
home. This scenario the lender will actually fund the full purchase price of
the investment property,
plus the additional costs. When you add the two property values together, you
have a total security value of $900,000. And by adding the two loan amounts
together, you have $715,000 worth of debt. As an overall percentage, your total
borrowings equal 79.50%. This one this is under the 80%, LMI threshold and
no mortgage insurance would
be payable. This all seems easy and often.
In this second scenario, you need
to be aware that both properties will be tied together, or
cross-collateralized. This means that the lender secures both properties
against the total debt. And this can cause potential restrictions. If you
decide, you wanted to refinance one of the properties to another lender in the
future or it could limit your options if you want to sell one of the
properties.
For example: - If
you sold your home for $500,000. You would have to pay down the debt against
the investment property. And to what level would be dictated by the lender in
this second scenario the outcome is the same, the structure is different. You
have a property and your property is worth $500,000 with a loan of $300,000
against them. We set up an equity facility
or a drawdown facility for $100,000, and that is with the same lender. When you
purchase an investment property for $400,000 and we use $95,000 from the equity loan to cover your 20%
deposit, plus the associated costs. Then we set up another loan with a
different lender. That represents 80% of the purchase price. Our total security
value is $900,000. And our total debt level is $715,000 that’s representing our
79.5% loan-to-value ratio. You can see our n numbers are exactly the same.
We have added two further steps
the reason for this is to give your home, some protection against any possible
problems with the investment property.
For example:- Your
tenants stopped paying your rent and you cannot afford to repay the $320,000
loan by yourself. If that $320,000 investment loan falls into default, and
lender B is then forced to foreclose on the investment property.
This is the worst case scenario.
Under this structure then 2 B does not hold the title deeds to your home. And
therefore does not have the power to sell your home. If there is a potential
shortfall, we refer to this as spreading your risk across lenders or not
putting all your eggs in one basket. Accessing equity to invest should always
be part of a well-thought-out plan and you should consult with your financial
adviser or accountant, before speaking with your broker.
I hope you've enjoyed this
article. Our aim is to keep this article short, and to the point. That you can
refer back to these in the future, and also pass them on to your friends. If
you feel this information would help them.
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