How to use equity in your home to buy an investment property
If you have owned your property for more than three years, chances are it has gone up enough in value for you to unleash some equity and help you buy another property.
So how does this work and just how much of this uplift can I access?
Let’s look at an example.
Firstly at an 80% LVR. ( I’ll explain what this means shortly).
You purchased your home for $800,000 two years ago. You borrowed 80% of the value and your loan was $640,000. You have managed to pay this down and it is now $620,000 as you have been making regular repayments of interest and principal.
The market has improved and your home is now worth $1,000,000. A common misconception is it has gone up by $200,000 so you can borrow this $200,000 which is not the case. Remembering if we wish to avoid mortgage insurance we need to stick to an 80% loan to value ratio (LVR).
This equates to an $800,000 maximum loan of which you owe $620,000. This means you can potentially borrow $180,000 against your home for the purpose of buying an investment property.
So how do we use this equity towards an investment property?
Let’s say you wish to buy an investment property for $700,000 which will receive rental of 3% per annum. On this new property you can borrow 80% (again to avoid mortgage insurance).
This will mean a loan of $560,000, but you still need to come up with the difference in the loan and the purchase price and also buying costs of say 5% or $35,000 in this example. This means you need additional funds of $175,000.
Assuming you can show you can afford to repay a new loan:
- You can borrow against your home to cover the deposit on the new property. It’s called an equity extraction. Earlier we showed that you have $180,000 equity available- so that’s sufficient to cover the $175,000 deposit and costs needed to buy this property.
- You can then borrow against the new property to say 80% of the value of the new property without having to use any cash towards the purchase.
The Lender will assess your ability to afford the new loans factoring in:
- potential rental on the new property with a shading for vacancies.
- Expenses for the new property to hold the asset such as rates, levies, maintenance, agents fees etc.
- Depending on the lender, negative gearing on the new lending may be factored in which boosts your borrowing capacity.
- Even if you choose to have interest only repayments the lender will still need to assess your ability to repay the loan in full of the remaining term of the loan. So while you may feel you can afford the out of pocket expenses based on interest only repayments - the lender may think otherwise.
- Of course all your other expenses and commitments and income is included as it was when your initial loan was taken out.
How to structure this debt?
This is one for your accountant. Whether you buy in person names, company or trust or perhaps varying ownership percentages if buying as a couple depending on incomes and tax brackets.
One potential structure which you should run past your accountant is interest only repayments on the investment debt whilst paying principal interest on the owner occupied debt.
This allows you to steer your surplus cash towards your owner occupied property which has no tax benefits whilst keeping the interest high on the investment property. Interest on investment property debt is tax deductible so this can be an effective tax strategy. See your accountant about this.
Should I use my cash towards the investment purchase?
Again another one for your accountant, but they may suggest to use your cash to pay off your home loan as there are no tax benefits, and borrow the full amount. The overall debt position will be the same but the tax for the purpose of buying an investment will allow you to maximise tax deductions therefore improving the overall cash flow.
Can I borrow 90%?
Yes. If the equity in your home isn’t quite enough to get an equity loan up to 80% you can seek a 90% loan but it’s important to note if you borrow 90% of the value of your home to say unleash $100,000 you will pay LMI not only on the new money but also the existing debt so it can be very expensive. Not only that but many lenders won’t let you borrow equity for an investment property using LMI.
A more economical option may be borrowing up to 80% on the home and then taking a new loan of 90% against the new home.
If you need assistance to understand if you can unleash the equity in your home and qualify to buy an investment property reach out on 0456533439 or tina@ariafinancial.com.au