What exactly is home equity?
Simply put, home equity is the difference between the current value of your property and how much you owe on it.
If you have been paying your loan for a few years, you may have built up reasonable equity. For example, if your property is worth $500,000 and the current debt on your loan is $290,000, your equity would be $210,000.
Can you use your home equity to buy a second property?
The short answer is yes. You can borrow against your equity to purchase another property. But not just that, you can also use your home equity to fund other big-ticket purchases, such as renovating your home or starting a new business.
A common way to access your home equity is to refinance your current loan. By borrowing against your home equity, your existing property becomes a security on the loan.
Understanding total equity and useable equity
We’ve established that you can use your home equity to buy another property. In the example above, your equity would be $210,000. Does that mean that you can put this amount towards a deposit on a second property?
How much can you actually borrow?
Using the example above:
- Property value: $500,000
- 80% of property value: $400,000
- Minus current debt on loan: $290,000.
- Your useable equity would be $110,000.
How much useable equity you’ll be able to use will vary between lenders. Still, as a rule of thumb, lenders will generally lend you only 80% of the value of your home, meaning that your useable equity should amount to at least 20% of the property value to be used as a deposit. If your useable equity is less than 20%, you may need to add from your pocket to make up the difference or consider other properties.
It’s worth noting that it’s possible to borrow more than 80% if you take out Lenders’ Mortgage Insurance (LMI).
Property experts suggest, however, that when it comes to buying an investment property, you should use the “rule of four”, which consists of multiplying your useable equity by four to find out your maximum purchase price.
Accessing your equity is a great strategy to buy an investment property, but just like any big financial decision, it shouldn’t be taken lightly.
Our specialist mortgage brokers can help you to work out how much home equity you have and the best way it can be accessed to fund your next investment. Book a free chat today.