Maximising Your Equity: The Path to Buying Another Property

By: Aaron Robbins0 comments

Taking steps towards building your investment portfolio or financial assets can be easier when you have an existing property to use as a stepping stone. Especially given the recent boost to Australian property prices, many property owners now hold more equity in their property assets.

Business owners are no exception; whether it’s a personal or commercial property, they can leverage the existing equity they hold to purchase another property, office space, franchise, workshop or storefront. Keep reading to find out how you can maximise your equity to buy a second property.

How does equity work?

Chances are that if you’re an existing homeowner or property owner, you’ve got equity tucked away in your property value. Equity is essentially the portion of your property’s value that you own, not the bank or financial institution. If you’re in the privileged position to own a property outright, then you’re considered to hold 100% of the equity in that home!

To calculate the equity in your home, a basic equation is to simply subtract any debt against the property (usually, the outstanding loan balance) from the property value.

There are generally two ways that equity is built:

1. Paying down the principal of your home loan, investment loan or commercial loan

When you make interest repayments off a loan, the value of those repayments doesn’t go towards paying off the purchase price of the property, but rather, the interest charges from the financier. What this means is that, if your home loan is an interest-only loan, then the repayments you make generally aren’t building any equity in your home; they’re simply covering the interest charges.

However, if your existing home loan or investment loan is set up under a ‘principal and interest’ repayment format, then your repayment amount will go towards making interest repayments as well as paying down the principal in your loan balance. Essentially, the more money you can put towards paying down the principal of your loan (such as through making extra repayments), the more you build equity!

Some common strategies to increase equity quicker by paying down the principal include:

  • Shorten the term of your loan. With a shorter loan term, your repayments will be higher. This pays down the balance faster and increases equity more quickly than a longer loan term.
  • Increase your repayments. Increasing your repayments to be above the minimum means you’re chipping away at the balance faster. Essentially, every extra dollar you contribute is a dollar more of equity — and helps to reduce your interest expense!
  • Contribute tax refunds or bonuses to your home loan. By putting large sums of money onto your home loan, you are increasing your equity by that amount.

whitebrown house

2. Your property’s market value rising

The other way that equity is built is through the value of your property rising. The property market in Australia is starting to cool, however, in the past year, some areas of Australia have experienced property price growth of over 40%! Given that equity is the difference in the property value vs the outstanding debt against it, the higher the value, the more equity there is.

Many property owners calculate their equity of the maximum purchase price that they expect to receive at any given point in time, however, your home loan equity is typically calculated using a bank valuation.

Some common strategies to increase equity quicker by increasing market value include:

  • Improve your property. Renovating or installing in-demand features (for example, a pool) can help to increase the value of your property, which in turn increases your equity.
  • Get another valuation. Banks and other lenders use different valuation methods. The market value determined by one lender could be different from another lender. Getting a valuation and refinancing could see you increase your equity.

couple holding pait rollers

How to use equity to buy another property, such as an investment property

When thinking about a property purchase, you’ll likely be aware that a deposit is required. The deposit doesn’t need to specifically be a cash deposit — you can use the equity in your current property (whether it’s your principal place of residence or an investment property) as the deposit.

Using equity to buy an investment property gets simpler as your property portfolio grows. As you generate income from the properties, and the loans are paid down, the equity across your portfolio continues to grow, which can be used to purchase further properties and continue with your wealth creation.

Things to bear in mind before purchasing a second property or getting a new loan:

  1. There are almost always legal fees associated with purchasing property, whether it be a commercial space or a second house. You’ll also need to factor in the relevant stamp duty charges, applicable to your state or territory, so while your equity may be high enough to satisfy the loan-to-value requirements of the property value, you may not have quite enough to cover the additional fees associated with purchasing property.
  2. Depending on how your existing loan is structured, using your equity in your existing home may have an effect on your home loan repayments.
  3. Interest rates will have undoubtedly moved since you first took our your mortgage, and are likely to continue moving. Consider any interest rate adjustments, and whether you will need to pay interest and principal repayments on your second loan.
  4. While many investors are attracted to interest payments being tax deductible on investment loans, there are other tax implications to owning investment properties. Even if you see a mortgage broker, they will only be able to provide general information, and cannot provide tax advice. This is why its important to always speak to an accountant or financial adviser if you feel you need to, prior to making large financial decisions.
  5. Don’t forget to budget in other ancillary costs such as mortgage insurance.

How much equity can I use?

When considering how much equity you can use as a deposit, the useable equity amount needs to be determined in order to satisfy LVR requirements.

For example, you have a property with a current value of $250,000, with a loan balance of $150,000. You have $100,000 in equity, but this is not the usable equity amount.

Calculating your usable equity

If the lender has a maximum LVR of 80%, they can only lend you a maximum of $200,000 against the property value of $250,000. With a loan balance of $150,000, this means you have $50,000 of usable equity (the maximum loan amount of $200,000 minus the loan balance of $150,000).

This $50,000 of equity is then used as the deposit for your next property purchase, with the loan secured by both properties. With an LVR of 80%, the maximum amount you could borrow for an investment property is $250,000 — which will need to cover stamp duty and additional purchase expenses.

What to remember when using equity as a deposit

To use equity as a deposit, it’s important to remember that you need to calculate the usable equity amount and not simply go by the amount of equity in your properties.

The figures used above are not reflective of current market values, they were used for the purpose of keeping the example simple. And for the purposes of servicing a loan, a lot more goes into the calculations, such as your personal circumstances, financial situation, cash flow, potential rental income, the interest rate etc.

If you’re looking to borrow money using equity to buy an investment property, it’s a good idea to get a professional to help with the calculations.

Can business owners get into property investment?

Absolutely! While many investors use their home equity for investment purposes, it’s just as feasible to use equity in a commercial property too.

preparing for work

What can a business owner use equity to buy?

If you’re a business owner with equity in your home, an investment property, or commercial property, you have the option to use this equity to invest back into your business. A caveat loan or a home equity loan can help business owners access equity to:

  • Boost their business’ working capital.
  • Fund renovations or home improvement projects.
  • Consolidate debt or repay ATO and business debt.
  • Cover lifestyle expenses.

If you’re interested in accessing equity with a current property to join the growing number of business owners turned property investors, contact Diverse Funding Solutions to chat about your goals and the finance solutions available to you.

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