What is home equity – and how can I use it to buy an investment property?

Ever heard people talk about ‘buying an investment property with no money’?

What they’re often talking about is equity.

Depending on your situation, even a home you bought 1 – 2 years ago may have enough equity to use as a deposit for your next property purchase.

While home ownership rates are high in Australia, only a tiny percentage are property investors.

Lack of knowledge is one key reason that prevents people getting started investing; either being unsure about the market, location or how to invest. For example, many home-owners believe they need to pay off their home loan before investing in a property – which is not necessarily the case.

Understanding how equity works is a great place to start.

What does equity mean?

Equity is the difference between the market value of your property and the size of your current loan.

If you’ve paid down your loan and/or if your home has increased in value since you bought it, your equity increases.

You could then potentially borrow against that equity to fund:

• home renovations
• a new business
• big purchases – car or holiday
• a deposit for your next home or an investment property.

How much equity can you use?

As a simple example, if your home is worth $600,000 and there is $300,000 remaining on your home loan, you have home equity worth $300,000.

However, banks will typically lend you 80% of the value of your home (though it’s possible to go higher with lender’s mortgage insurance), less the money you still owe against it. This is known as your useable (borrowable) equity.

So as per the above example:

Value of your property: $600,000

Value of your property at 80%: $480,000

Minus your mortgage: $300,000

This means your useable equity would be $180,000.

How do you use your equity to buy an investment property?

Say you wish to purchase an investment property with a market value of $400,000, plus factoring in additional costs such as legal fees and stamp duty, for an additional $20,000.

Assuming you meet the loan approval requirements, the bank would fund 80% of the property’s market value – potentially more if you’re prepared to pay LMI. That is, 80% of $400,000 or $320,000.

Therefore, you would need $80,000 for your deposit, plus $20,000 for your purchasing costs. This could come from the equity in your existing home.

There are two main options for unlocking this equity.

1. Refinance your home mortgage. Obtain a home valuation, and a lender can then refinance your home loan based on its new value and allow you to withdraw based on the equity. (I.e. replacing your current home loan with a new one)
2. Home equity loan / line of credit. A home equity loan is a general term for any loan that lets you borrow against the equity in your property. Many such loans come in the form of a line of credit. You can use as much or as little of the credit limit as you like, and only pay interest on the amount you use.

Other considerations:

• Banks will assess your loan applications taking into account your whole financial situation, as per the normal process.
• Have a sufficient financial buffer in place in addition to the equity you’re planning to use for unforeseen events / costs
• Investing in property is a serious commitment and a long-term endeavour, so ensure you’re well educated and have done your due diligence on the property you intend to purchase or sought the relevant professional / financial advice
• Make sure you’ve got the best team around you prior to investing. For example, a great property strategist, broker, and solicitor.

This is a quick intro to how people go about ‘buying an investment property with no money’. But if you’d like to speak to someone about how this strategy may work for you, please book an appointment with one of our Ironfish property strategists.

Or if you’d like to learn more about property investment terms, please download our E-book ‘The A-Z Guide to Property.’

This article is intended to provide general information only, current at the time of first publication. It does not constitute any financial advice, offer, contract or inducement to buy. Investors are expressly recommended to do their own due diligence in relation to any investment decision they make and seek independent financial advice.