Equity vs Useable Equity: How to finance your investment property using home equity - Pearl Financial

Equity vs Useable Equity: How to finance your investment property using home equity

By Shane | Investing

Aug 13

The equity in your existing home can be used to borrow money from a bank to purchase an investment property.

To understand how you can use your equity to purchase an investment property, you will need to know the difference between equity and useable equity.

Equity

Equity refers to the difference between the market value of your property and any outstanding loans against it.

Here’s an example on how to calculate equity:

Market value of current property: $1,000,000 million

Outstanding loan on the property: $500,000

Equity: $1,000,000 – $500,000 = $500,000

However, not all $500,000 can be used to borrow money for a second property.

Useable equity

Useable equity is any amount of money (up to 90%) of the property’s value minus any outstanding loans on the property. Most banks will lend up to 80% of the value of a property. Some banks lend up to 90% but the loan will come with additional terms and conditions and will likely attract lender’s mortgage insurance (LMI).

Using the 80% LVR (Lending-to-Value Ratio) we calculate the useable equity of the above example:

Your home value: $1,000,000 x 80% = $800,000

Outstanding loan on the property: $500,000

Potential useable equity: $800,000 – $500,000 = $300,000

This means you may have up to $300,000 of useable equity to borrow money from the bank to purchase a second property.

How much can I borrow with my useable equity?

The general rule of thumb is to multiply your useable equity by four. This is obviously subject to the lender’s credit policy and assessment criteria.

Using the same example above:

Useable equity: $300,000 x 4 = $1.2 million.

There are several ways to access your useable equity. You can use it in lieu of a cash deposit or you can establish an equity access loan. Bear in mind, there are additional conditions and costs that lenders will impose.

One of the most important considerations is to ensure that your existing loan is properly structured and that you can afford the mortgage repayments of both loans.

Using equity to purchase a property can be an effective wealth building strategy. However, it is important that you consult a professional mortgage broker before you take the next step. One wrong step at this stage can set you back years. Investing is a journey best taken with caution.

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About the Author

Shane specialises in helping Gen Y professionals and business owners make an impact by accumulating more assets, generating more income, and having more time to enjoy life. He has a Master of Applied Finance, an MBA, and a Master of Financial Planning. He is also a terrible golfer.

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