Understanding How Equity Works

To better understand how to leverage equity for property purchases, it’s important to first have a clear understanding of what equity is and how it works. Equity is built over time as you pay off your mortgage and the value of your property increases. Your home becomes an asset that you own, rather than something you owe money on.

How to do equity valuation?

Equity valuation is the process of determining the value of your home equity. This can be done in a few different ways, including calculating the current market value of your property and subtracting the remaining mortgage balance. Other factors that may affect equity valuation include any renovations or improvements made to the property, as well as changes in the overall housing market.

Types of equity

There are two key types of equity that can be used in this context: usable equity and non-usable equity.

Usable equity

Usable equity is the portion of your home’s value that you can safely use for investing without affecting your loan-to-value (LTV) ratio.

• To calculate your Loan-to-Value Ratio (LVR), simply divide the loan amount by the purchase price or valuation of the property you’re purchasing. This will give you a percentage representation of the LVR.

For example, let’s consider a scenario where you want to borrow $700,000 for a property valued at $900,000. The LVR calculation would look like this:

700,000 / 900,000 = 0.778 or 77.8% LVR

It’s important to note that the lower your LVR, the more usable equity you have available to invest in other properties or projects.

Non-usable equity

This refers to the portion of equity that either cannot be accessed due to lender restrictions or that you choose not to use to maintain a safe LTV ratio.

While usable equity can be directly leveraged for property purchases, non-usable equity simply contributes to the overall net worth of your assets, providing a financial cushion and increasing your creditworthiness.

Let’s explain usable and non-usable equity with an example.

Imagine you own a property worth $900,000, and you still owe $300,000 on your mortgage. So, the total value of your ownership in the house is $600,000 ($900,000 – $300,000).

But not all of this $600,000 can be used. Let’s say your lender allows you to borrow up to 80% of your home’s value. That’s $720,000 ($900,000 x 0.8), but since you already owe $300,000, you can only borrow an additional $420,000 ($720,000 – $300,000).

So, currently, you’re using only $120,000 of your usable equity ($600,000 – $480,000). The remaining $380,000 is non-usable equity contributing to the overall value of your assets.

Using equity to buy property

The equity in your property can be leveraged to purchase additional properties to grow your real estate portfolio. A common strategy used by many property investors, this process is known as “equity release” or “equity transfer”.

One way to use your equity is through a home equity loan or to borrow against the value of your property. These loans typically have lower interest rates as they are secured by the property itself.

Another option is to refinance your mortgage and take out a larger loan amount, using the extra funds to purchase a new property. This strategy is often used when interest rates are low, making refinancing a more attractive option.

Equity release allows you to access the non-usable equity in your property by borrowing against it. The borrowed amount is then used for investments, while the property remains as collateral.

Equity release can be a powerful tool for property investors, as it allows them to acquire new properties without having to save up for a down payment. However, it is important to carefully consider the risks and potential returns before making any decisions.

Talking to a financial advisor can help you determine if using your equity for property purchases is a suitable strategy for your individual situation. They can also guide you through the process and help you make informed decisions.

Pros and Cons of Using Equity to Buy Property

While equity release can offer many advantages for property investors, it is important to carefully weigh the pros and cons before making any decisions. Here are some potential benefits and drawbacks of using your equity to purchase additional properties:

Pros:

• Access to funds without having to save up for a down payment
• Ability to diversify your real estate portfolio by acquiring multiple properties
• Potential for higher returns through leveraging your existing equity
• Can be a useful tool for those with limited savings or who want to take advantage of low interest rates

Cons:

• Potential for decreased cash flow, as borrowing against your equity can increase mortgage payments and reduce rental income
• There is a higher risk involved when using your equity for investments because the value of your property may be tied to market conditions.
• May incur additional fees and charges such as lender’s mortgage insurance or early repayment penalties

Equity as a Property Investment Tool: Is it worth it?

A lot of investors find that using their equity for property purchases can be a successful strategy. If and when you decide to use your equity to purchase another property, it is important to have a well-thought-out investment strategy in place to help offset any risks and maximise return on investment.

Before accessing your equity, be aware of any extra fees or charges and do your homework on potential lenders. Always consider your investment goals, risk tolerance, and financial situation before making any decisions.

Unlocking the equity in your property is a powerful tool that can help property investors achieve their financial goals. When you are well-informed and have a solid plan in place, it’s time to start looking around for your next investment-grade property.

Conclusion

Building a successful investment property portfolio requires careful planning and research. Using your home equity to purchase another property can be a powerful tool, but it’s important to approach it with caution and informed decision-making. By considering the various factors involved and consulting with professionals, you can make the most of your equity and achieve your financial goals.

At Ironfish, we are dedicated to empowering investors to take their investments to the next level. By providing expert advice, access to quality properties, and ongoing support, we aim to help our clients build a strong investment portfolio for long-term financial success. So if you’re ready to make the most of your home equity and build a successful investment portfolio, contact Ironfish today.

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