How to use equity to buy my first investment property
Equity is one of the most powerful tools for property investors. If you already own a home, your equity could be the key to purchasing your first investment property without needing to save a massive deposit. Understanding what equity is, how it works, and how to use it effectively can help you leverage your assets to grow your wealth.
What is equity?
Equity is the difference between the current market value of your property and the amount you owe on your mortgage. For example:
- Current Property Value: $800,000
- Mortgage Balance: $500,000
- Equity: $800,000 - $500,000 = $300,000
Equity grows over time as:
- You pay down your mortgage.
- Your property's market value increases.
Types of equity
Total equity
This is the full amount of equity you own in your property, as calculated above.
Usable equity
Usable equity refers to the portion of your total equity that lenders allow you to access for borrowing. Most lenders let you borrow up to 80% of your property’s value, minus your mortgage. For example:
- 80% of property value: $800,000 × 80% = $640,000
- Usable equity: $640,000 - $500,000 = $140,000
This $140,000 is what you can potentially use as a deposit for your investment property.
How to use equity to buy an investment property
Step 1: Determine your usable equity
Get your property valued by your lender or a professional to determine its current market value. Subtract your remaining mortgage balance to calculate your usable equity.
Step 2: Speak with a mortgage broker
A mortgage broker can assess your borrowing capacity and guide you on how much you can borrow using your equity. They’ll also help you understand the implications of leveraging equity for an investment loan.
Step 3: Choose the right loan structure
When using equity, there are two common methods to fund your investment property:
- Equity loan (top-up loan): This involves increasing your existing home loan by the amount of usable equity. The extra funds act as the deposit for your investment property.
- Cross-collateralisation: In this method, both your existing property and the new investment property are used as security for the loan. While this can allow you to borrow more, it’s riskier as both properties are tied to the same loan.
Step 4: Purchase the investment property
Once your lender approves the loan, you can use the released equity to pay for the deposit and associated costs, such as stamp duty, legal fees, and inspections.
Benefits and risks of using equity to purchase an investment property
Benefits
- No need for a cash deposit: Using equity eliminates the need to save a traditional deposit, accelerating your entry into property investment.
- Leverage to grow wealth: Equity allows you to leverage your existing assets to acquire additional properties, potentially compounding your returns.
- Tax benefits: Interest on the investment loan is often tax-deductible, which can reduce your overall tax burden.
Risks
- Increased debt: Using equity means taking on more debt. Ensure you can manage the additional loan repayments, even during financial challenges like rising interest rates or property vacancies.
- Market fluctuations: If property values drop, your equity could decrease, putting you at risk of negative equity (owing more than the property is worth).
- Impact on cash flow: While leveraging equity can build wealth, it’s essential to maintain strong cash flow to cover all property-related expenses.
Equity is a powerful resource that can help you buy your first investment property and kickstart your journey to building wealth. By understanding how equity works and working with the right professionals, you can leverage your existing property to grow your portfolio strategically. Ready to take the plunge? Start by assessing your property’s equity and exploring your borrowing options today.
