You’ve been paying off your mortgage fastidiously for decades. Not only have you been paying down your debt, you’ve also been raising your equity. Did you know you can use that equity to create even more wealth?
If you’ve ever wanted to buy an investment property, but haven’t been able to save a mortgage deposit while also paying off your primary mortgage, there may still be a way to get there.
You can use the equity you’ve built in your primary home to fund the deposit, or as backing for the mortgage on your second. More on that in a moment, but first …
What is home equity?
Russell Munfaredi, managing director at Mortgage Pros, explains that home equity is essentially the portion of your home that you truly own. It’s the difference between the market value of your property and the outstanding balance on your mortgage.
As you pay down your mortgage over time and your home’s value (hopefully) increases, your home equity grows.
To determine how much equity you have in your home, start by researching the current market value of your home and subtracting your outstanding mortgage balance.
The resulting figure represents your home equity. So, if your home is valued at $500,000, and you have $300,000 left on your mortgage, your home equity is $200,000.
There is a difference, however, between your raw home equity and what’s known as your ‘usable’ or ‘borrowable’ equity, which is determined by the lender you want to borrow from.
For example, major banks will usually only lend you up to 80 per cent of your home’s market value. So in the situation above, the bank would lend you a maximum of $400,000.
If you’ve paid off $300,000, then your usable equity in this instance is $100,000.
How do you use that equity to buy real estate?
Once you’ve determined your home equity, you have three options for using it, says property investment site Property Update: a line of credit, getting the equity paid out as a lump sum, or what’s known as ‘cross collateralisation’.
Line of credit
Using your equity as a line of credit works in a similar way to a credit card. You’ll gain access to the full amount of your equity, but will only be required to make payments on anything you spend.
This option can be beneficial if you have a lot of equity in your home and don’t require the full amount for a deposit on an investment property. It can also be useful for conducting renovations on your primary home.
Lump sum payment
As the name suggests, this option involves getting a lump sum payout from your equity. This has the benefit of giving you access to a large amount of cash quickly, but the downside of having to service the entire amount of your loan straight away.
Cross collateralisation
This option is a little more complex and usually involves having both your primary mortgage and investment property mortgage with the same lender.
Brett Warren, from property investment site Property Update, explains it as a ”strategy that involves using the equity from your existing property as security for loans on both properties”.
“So instead of releasing your equity to use as a deposit for a separate investment property mortgage, quite often with a separate lender, your loans will be linked by the fact that the equity in one property is used as the collateral for both.”
This is the riskiest option of the three, because if you are unable to make the payments on either loan for any reason, there’s a risk of losing both properties.
Using home equity to invest in real estate is a financial strategy that can open doors to wealth-building opportunities. By understanding your home equity, exploring your financing options, and making informed decisions, you can leverage your property’s value to potentially create a source of passive income through real estate investment.
How much equity do you have in your home? Would it be enough to cover the deposit for a second? Let us know in the comments section below.
Also read: Where is Australia’s housing market headed in 2024?
