If you are already a home owner you may not need to provide a deposit to fund the purchase of an investment property. Instead you may be able to harness the power of your home equity.
Home equity is the difference between your home’s market value and the balance of your mortgage. If you have owned your home for a few years there’s a good chance you have built up some reasonable equity, and this can be a valuable resource when it comes to property investment.
Here’s how it works. Let’s say you want to buy an investment property with a market value of $400,000. There are also additional purchase costs (legal fees, stamp duty and so on) of $20,000, bringing the total cost to $420,000.
Assuming that you meet the loan approval requirements, a lender will fund 80% of the property’s market value (potentially more if you are prepared to pay Lenders Mortgage Insurance). That is, the bank will lend you $320,000 to buy the investment property. As the total cost of the property is $420,000 you still need an additional $100,000 for the deposit. This can come from the equity in your existing home.
Let’s say the market value of your existing home is $500,000 and the balance of your mortgage is $300,000. The difference between the two is $200,000, which is your home equity.
As an investor you can access up to 80% of your home equity, which equates to $160,000 in this example (without the need to take out LMI). Instead of coming up with a cash deposit for the additional $100,000 needed to buy the investment property, you can take this from the $160,000 of accessible equity in your existing home.
The below tables show how this is calculated.
Property investment loan
| Investment | |
| Market value of investment property | $400,000 |
| Additional costs | $20,000 |
| Total costs | $420,000 |
| Loan amount (ie. 80% of market value) | $320,000 (ie. $400,000 x 80%) |
| Shortfall (ie. Total cost - Loan amount) | $100,000 ie. $420,000 - $320,000) |
Tapping into home equity
| Existing home | |
| Market value of existing home | $500,000 |
| Balance of loan | $300,000 |
| Home equity (ie. Market value - Balance of loan) | $200,000 (ie. $500,000 - $300,000) |
| Accessible equity (ie. 80% of home equity) | $160,000 (ie. $200,000 x 80%) |
You should note that many property investment gurus say it is important to repay the loan on your home as soon as you can. The equity that is drawn down from your home to purchase an investment is tax effective, however any remaining debt on your home is not. Therefore the loan on your home costs you much more on an ongoing basis than the loan on your investment property.
The property that you live in is not the only source of home equity. You can also use the equity in an existing investment property to help fund the purchase of another investment property.
At Arafura Finance Brokers we are long term property investors and can help you work out how much equity you have in your property and how it can be accessed as a source of funding for your investment property.
The above information is provided for general education purposes only and does not constitute specialist advice. It should not be relied upon for the purposes of entering into any legal or financial commitments. Specific investment advice should be obtained from a suitably qualified professional before adopting any investment strategy.