The equity held in your property can be a powerful tool for wealth creation. Used properly, this equity can secure the finance needed to achieve your property investment goals.
Put simply, if your property has increased in value, the amount of equity held in that property will have gone up too. You can access that increased equity, which can then be used to meet the deposit and costs on another property purchase.
To work out how much equity you have in your property, you’ll need to subtract any debt remaining on your mortgage from the property’s overall value. So, if your property is worth $500,000, and you have $300,000 left on your mortgage, then your equity is $200,000.
Your property’s equity will increase both as you pay off your mortgage and as the property’s value increases. So, if your $500,000 property increases in value by 10% over 12 months that’s an extra $50,000 in equity. Add to this any deduction to the mortgage gained through repayments, and your equity has significantly increased over the year.
Once your property has increased in value, whether that be through capital growth, renovation, or diligently paying off your mortgage, it is possible to use the increased equity as to secure further lending.
The bank will calculate a loan to value ratio so that they can keep back some equity as security. If you have a property the bank is comfortable with, then they may release 80% of the property value.
In the example above, if you have a $500,000 property and you have a debt of $300,000, the Bank may lend 80% against the property value ($400,000), deduct the existing loan ($300,000) and then you can take the usable equity of $100,000 to pay the deposit and costs for another investment property.
There can be a range of benefits and risks in releasing the equity in your home and using it for investment―you could
- have an opportunity to build wealth more quickly
- benefit from gearing (and use any savings to pay off your home loan or other non- tax deductible debt
- The main risk is that you are borrowing the whole purchase price and purchase costs – higher borrowing means higher loan interest costs.
- borrowing against the value of your home—which is how you access your equity—may enable you to buy an investment sooner than if you had to save the money. What’s more, owning an investment gives you the opportunity to generate an extra source of income down the track. And a strategy like debt recycling can help you pay off your home loan sooner using the income from your investments.