One of the best way to quickly buy multiply investment properties quickly is to drawn down on the equity in your own home or your investment property. In this article, we explore how you can tap into this equity and quickly grow your wealth through property.
What is equity?
A realisable wealth creation strategy for homeowners is to use existing equity in their property to accumulate properties and build up their property portfolio. In short, equity is the value of the current property less the money owing on that property. The money owing on that property is generally classed as the equity component.
How do you get started?
To access this equity, you should meet with a specialist that understands investing, negative gearing and being able to tap into equity. Tell them your current financial position and they should work out your capacity to borrow the money against your owner occupied property. Once you have preliminary pre-approval, the next step is to organise an independent evaluation.
Make sure you go to a lender that gives you access to that independent valuer. Your mortgage specialist would ideally instruct a panel valuer, whose evaluation can be used by several lenders.
How do you calculate how much you can access?
Subtract what is currently owed on your property from its overall value. For example, say you owe $250,000 and your home valuation came in at $500,000. Using a rule of thumb of 80% of the value of the property, borrowing up to 80% gives you a pre-approved equity limit of $400,000. If you subtract the balance outstanding, you have an additional $150,000 in equity available that could be used for a deposit and costs on other investment properties.
Borrowing up to 80% of the value keeps you out of the realms of mortgage insurance. Mortgage insurance doesn’t protect you the borrower, just the lender.
How can you leverage equity to buy another property?
Once you know what the figure would be, you can work out the best way to use that equity. One option is to buy one property, but you could potentially buy two properties and divide that $150,000 into two sub-accounts.
Account 1 would be your principle place of residence, the owner occupied property containing a mortgage of $250,000.
And 2 sub accounts of $75,000 each, which is our ideal scenario. Approach a mortgage specialist with access to various funding lines.
For example, lets say that you buy an investment unit to the value of $300,000 and borrow up to 80% of the value of that unit. This means a stand alone loan against the first investment unit of $240,000. The difference between the $300,000 purchase price and $240,000 is $60,000. That $60,000 we would access out of the equity of the owner occupied property (ie sub account 1), leaving $15,000 for acquisition costs including stamp duty, legal fees, valuation fees etc. This still leaves sub account 3 to duplicate the process and acquire another investment property in the very near future.
What is cross-collateralisation, and how can that affect/impact your ability to access equity and grow your portfolio?
It may be advisable for your mortgage specialist not to go to the same lender for your investment property as your owner occupied property.
The reason is that going to one lender for all of your mortgage transactions might see lender taking the view of trying to secure their position by cross collateralisation of all your assets/properties in the one mortgage document.
I recommend to keep every property as a stand alone transaction, so if down the track you want to sell one of your properties you could do so without it affecting any of your other business transactions or owner-occupied debt.
What kinds of fees and charges would be involved in refinancing to access your equity?
After speaking with your current lender and speaking with other mortgage specialists, you may feel refinancing your home loan is a viable option. Nowadays refinance costs aren’t so great. The main cost component by doing so is usually stamp duty. Some state governments have exempted stamp duty from being paid. Using our previous example, what that means is that if you refinance your original loan of $250,000, you are not need to pay stamp duty on that figure, but on the $150,000 equity component.
This can vary from state to state but as a guide you would pay around $500 in stamp duty for this component, so it is not an insurmountable sum. Other costs you may need to factor in are the updated valuation and costs in relation to preparing the mortgage documentation. Costs here may total around $600 on top of the stamp duty.
If you are currently on a fixed rate there may be some exit costs in getting out of that loan, or if you have had your loan for only a short period of time with your current lender there might be early repayment penalty fees. Your mortgage specialist will work out if it is cost effective refinancing to a different lender or remaining with your existing lender, if they have the suitable products to do this.
Also make sure your equity loan is a ‘set and forget’ facility, which means they don’t ask you to provide financial details on a regular basis. Your financial position should be only assessed once and that is when the loan documentation is processed and application approved.
The other thing to be cautious of is to make sure you are not charged any annual or ongoing package fees, particularly when the documentation says ‘fees and charges may vary.’ If it is $300 in fees today it could be worse down the track.
When continuing your wealth creation strategy it is best to speak with a mortgage manager or specialist. Some banks or loan managers simply don’t understand lending for investment strategies. Once you start accumulating a substantial property portfolio their concerns might prompt a move to cross-collateralisation and this is what you want to avoid. It can halt your wealth creation strategy and you may miss out on opportunities that come to along, which your lender might not fund because of their reluctance to greater risk exposure.
Every 5 to 7 years look at reassessing the situation and revalue all your properties, including your owner occupied and investment properties. By doing this, you will invariably see the value of the property and equity increases. Even if you only pay interest on the investment components going forward, you can then start tapping into the equity from the investment property and keep duplicating the process – this is when you really start that extensive property portfolio. In doing so, you could even access equity to free up the loan on your owner occupied property. This property could be unencumbered and the mortgage is just transferred across to another investment property.
What types of loans are available?
Using your equity is one of the most cost effective ways to expand your property portfolio and employ a great wealth creation strategy, but an equity loan can be like a big credit card. If a portion has been allocated for investment debt, don’t draw on the money for personal debt.
When it comes time for your tax return, things can get messy in regard to what was taken out for personal expenditure and what portion is investment debt.
Your accountant may even charge you more if he cannot ascertain how you used this equity with any degree of ease or transparency.
In keeping with any wealth creation strategy, discipline is the key because a sudden influx of funds may tempt you to use your equity in other ways- for instance a new car or overseas holiday. If the aim of your loan was for property investment purposes, stick stringently to this path. As in the previous example, if you are going to turn what was a $250,000 debt into a $400,000 one, you may ideally want something to show for it down the track – not just some nice memories of your trip to the Bahamas.
Find a good mortgage expert or book a free appointment with our mortgage broker - one who understands you dreams and aspirations for wealth creation. It will be the first step in being well on your way to achieving those dreams.