Home Equity Loans for Investment Properties: Is it Right for You?
One of the key challenges of buying the first investment property is saving enough for a deposit. Homeowners will often struggle to pay back the mortgage on the home they are living in, and also find the spare cash to build towards that deposit.
For this reason, many homeowners will dismiss their dream of becoming an investor and owning multiple properties to generate passive income.
But having a mortgage can actually be an advantage when it comes to property investing. If you are an existing homeowner looking to buy an investment property, you may be in a position to access the usable equity in your current home.
Using home equity for investment property can be a tricky concept for new investors, so let’s start with the basics.
Equity: What is it and how can it be used?
Equity is the difference between the current market value of your home and your remaining mortgage balance. For example, if your house is currently worth $600,000 and you have a remaining mortgage to pay of $200,000, your equity is $400,000.
If you’ve just acquired your home, then chances are you’ll still be building up that equity. But if you’ve had a mortgage for sometime now, you may find you’ve steadily been building up your equity. And if the market value of the property has increased, it’s likely that you’ll have gained equity just by owning a growth property.
You may be in a position to access this equity for various purposes. This is known as ‘borrowing against’ the equity in your home.
But to do so that equity has to be ‘usable equity.’ This is equity in your home that you can actually access and borrow against. It’s worth consulting a mortgage broker to determine the usable equity in your home, along with a formal bank valuation to determine the current value of your home.
Keep in mind that even though you might have enough equity in your home, some lenders may not always allow you to access it. This decision can be influenced by a range of factors, including your income, age, additional debt and employment status.
Using equity to buy an investment property
The usable equity in your home may be used to contribute towards any financial goals, with one option being to buy an investment property with equity. There are a range of methods that can be used to do this:
- Home loan top up: This involves applying to increase your existing home loan limit to provide funds. This is probably the most common way to borrow against the equity in your current home, with the top up paid into your account which can then be used to secure the deposit on your next property.
- Supplementary loan account: This option involves using your equity to set up a new, supplementary loan account. This is beneficial when you want to choose new features for this particular loan, such as new repayment frequency or the type of interest rate.
- Cross-collateralisation: The final strategy involves using the existing property as collateral and adding it to the new investment property loan. This means you’ll have the original mortgage secured by existing property, as well as the new mortgage secured by existing property and investment property. Keep in mind that this option gives you less flexibility, with more work involved if you aim to sell one of those properties in the future.
Continuously building your property portfolio only increases the benefit of using equity. It allows you to borrow that equity increase each year from a different property, generating passive income to live off.
However, all properties need to be increasing in value for this to work. Increasing the rental income from these properties is also a key aspect of maximising this strategy, so that you can cover the cost of repaying the newly loaned amount.
What to consider before accessing equity for property investment
Before jumping straight into using your home equity for investment properties, it’s worth considering a few of the following factors.
First, you need to make sure you’re in a position to take on that new loan and have enough cash coming in so that you’ll be able to make those new repayments. Not only do you need to have the funds to do this, but also have the time and proper strategies in place to manage the different repayment amounts, schedules and loan terms.
It’s also a good idea to have an investment strategy developed before becoming a property investor and especially so when you’re planning to use home equity to buy an investment property. You want to have a good grasp on your investment goals, including how many properties you want to own, when you want to own them, and whether you have the means of achieving this goal.
It’s important to acknowledge the risk involved when using equity for property investing. Not making your repayments on the loans means you could lose either of the homes. This could leave you and your family in a high-risk situation.
That’s why developing an investment strategy and knowing the limits of your resources (whether that be time, knowledge, or money) is so important. Doing so will be the difference between success and failure as a property investor.
Determining whether home equity loans for investment purposes is the right strategy will ultimately depend on the individual. Knowing whether it’s a good idea involves knowing the risks involved, how best to mitigate those risks, and the limitations you may face as an investor.
If you decide home equity loans are right for you, then this can be the perfect strategy to either open the door to property investing or accelerate the expansion of your property portfolio!