If you own a home, chances are you will want to know how to use your home equity. The challenge for most people is they don’t actually realise how to access it and or use it to their advantage. However, home equity loans are not for everyone and need to be used wisely otherwise you could end up in more debt.
What is home equity
Home equity is the difference between the current value of your home and how much you owe on it (your current mortgage).
It is the portion of your home that you actually own, and as such you can borrow some of this portion.
So, if your home is worth $500,000 and you still owe $300,000 then your home equity is $200,000.
The good news is, you can use your home equity as security with the banks. This means you can borrow against your equity to purchase an investment property, and by doing just that, you turn some of your “bad debt” into “good debt”.
What is bad debt
Bad debt is any debt that costs you money, that you have to repay from your earnings. Good debt, on the other hand, is debt that you have, that someone else pays – e.g. your tenant through renting your investment property., and the tax department, through reducing your income tax – again, because you have an investment property.
How to use equity to buy an investment property
Buying an investment property gets you started on creating your own investment portfolio and securing your future wealth and retirement plans.
Now there is a difference between total equity (in this case the $200,000 mentioned above) and useable equity.
Banks will usually lend you 80% of the value of your home, (which you might call a home equity loan), less the debt you already have. This is your useable home equity enabling you to use the equity to buy another house. The bank is lending this to you against the value of your home, so they won’t lend you the full amount.
Home equity calculator
Using our example above, let’s work out how you can use your home equity to buy another property using our simple home equity calculator.
Firstly, work out and write down how much your home is worth then write down the total mortgage on the property you still owe, these are the only two figures you need. Then replace them in our home equity loan calculator below.
Your property Value @ $500,000 (your figure goes here)
Value of your property @ 80% = $ 400,000 ($500,000 X 80% or 0.8)
Less your mortgage @ $300,000 (your figure goes here)
You have useable equity of $100,000 ($400,000 - $300,000)
Use the “Rule of Four”
When it comes to buying an investment property, the simple rule is to multiply your useable equity by four to arrive at your maximum purchase price of your investment property.
Using our same example $100,000 x 4 = $400,000. Remember the $100,000 if the useable equity we have from the example above, you can add your equity here and times it by four.
The banks will lend you 80% - being $320,000 in this case, against the purchase, and the property costs $400,000. This leaves $80,000, which is your deposit.
Add to your deposit, the costs associated with purchasing that property, such as stamp duty, legal fees etc. Usually around $20,000 on a $400,000 property.
So, the total funds needed to purchase a $400,000 investment property is now $100,000. This is your useable home equity, as shown in the calculations above.
Provided you can afford the new loan, together with your existing loan based on your income and expenses and including the projected rental income that your new purchase will afford you, the bank will lend you the money to start your investment journey.
The bank may lend you the funds through a home equity loan or a home equity line of credit. However, always consider your own circumstances, and seek the help of our Mortgage Broker to keep your best interests in mind.
Can you use a home equity loan for anything
Using your home equity is a serious decision, and squandering this on luxury cars and/or holidays will not be in your best interests. It takes years to build up equity in your home and turning that equity into more bad debt will not serve you well in the future, especially at retirement age. So, use your home equity wisely, and ensure that the decisions you make today lead you to a wealthy future.
Here are some popular ways to use your home equity wisely
Home Renovations: Use your equity loan or line of credit to finance improvements to your existing home
Property Investment: Use the equity to purchase an investment property, as discussed above. This will help you build for your retirement.
Debt consolidation: Because equity loans offer lower interest rates than other loans, you can use this to pay off a high interest bearing debt like credit cards and other loans. But this must be well managed, it's not a license to go and get more bad debt
Business: Use your equity to purchase a business you have always wanted or fund your way into one. We recommend discussing with your accountant or other financial advisors first.
Are you looking to purchase a home equity loan or investment property
Our experienced team has access to hundreds of home loan products as well as property investment packages to suit your needs and income. Contact us today for a free no-obligation personalised consultation.
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