Home Equity

Hi Ronnie,

So using the same example if I was to put a 20% deposit on a $600,000 property ($120,000) does that mean I have instantly a equity of $120,000 and be able to use it to invest in another property?

You are sort of correct – but wait, there’s more….. :p

To be able to use ALL of that Equity, you would need 100% loan AND extra cash/savings/Equity to cover purchase “costs” of another place.

Consider this – if you source finance on this place that has $120k Equity, and the financier allows a 90% LVR, then they would lend up to $540k (90% of $600k) – but you already owe $480k, so only $60k is USABLE Equity ($540k – $480k = $60k). But if you can get 100% Loan, then yes, $120k is available.

In the “usual world” (Mums and Dads) Equity growth happens over decades. e.g. they bought a place in the 80’s, paid $100k for it at the time. They would have been paying down a loan of $80k, and it would’ve hurt back then. By the 90’s it would likely have doubled (so, $200k) and doubled again by the “naughties”, to $400k. Maybe today it is worth $600k. Thirty years later, they have $520k Equity, plus whatever they have paid off the mortgage (probably the full $80k by that time).

Maybe they chose to utilise some spare equity in the 90’s to buy one investment property? With their $100k house then worth $200k, and needing just a $50k deposit to buy a $250k house, the Equity would be there (after just 10 years). They could have done it again in the 00’s too – as long as they could handle the DSR (Debt Servicibility Ratio) side of things. No problem with LVR (Equity) though.

As an investor though, we endeavour to “manufacture” Equity so that it grows more quickly – a reno, development, distressed buy, change of use, creative investing, etc. If we simply bought and waited, a positive outcome is virtually assured. Endeavouring to increase Equity brings its own reward, but also its own extra risk.

The above is also a good clue for those who “wonder why an Interest Only Loan can ever be a good way to go”. Using the above example, I would be thrilled to owe just $80k on a property worth $600k (I had owned it for 30 years, and had always just paid IO). Money saved by not paying down principal might’ve been buying another one (or two, or twenty) over that 30 year period.

I branched away from your initial question – hope the extra thoughts helped,

Benny

That’s where a good mortgage broker comes into the equation. There are a few on this forum I am sure one of them will raise their head shortly. Basically they split the original loan and the available equity portion becomes sort of like a ‘deposit loan’ which you can use for your deposit, then your application for the new property is only 80-90% LVR against the value of the property.
Don’t stress too much on it just leave it to the professionals..

ronnie01 wrote:

Hi Guys

I think I am beginning to understand so using a similar example if my property is 600k and I have 300k paid off and the banks will lend me 100% LVR than I will have access to the whole 300K to invest in another property? if the bank will only lend me 80% (600,000/0.8= 480,000) 480,000 – 300,000 = $180,000 equity? Is this correct?

Thanks guys

Yep – $180k in accessible equity. That’s keeping your LVR at 80%

Cheers

Jamie

Equity, It’s really is the magic ingredient that makes growing a portfolio possible, without growth in a property’s value there is no wealth being created.
Without growth in equity our only hope to buy the next property is to save every cent for next property purchase deposit or worse, having to sell one to buy another.

Luckily, equity is a very simple concept to grasp. At its most basic it simply means the amount a property is worth minus the amount owed on it.
However, not all the equity can be used because generally banks will only loan 80% of a property’s value, just in case it loses value. So the ‘useable equity’ is the amount the property is worth minus 20% and then minus the amount still owing.

Case Study

The sample property is valued at $450,000, the owner has a mortgage balance of $220,000 owing.

Owner’s equity: The property’s value $450,000 minus mortgage ($220,000) = $230,000

Useable equity: The property’s value $450,000 minus bank’s 20% ($90,000) = $360,000

Borrowing capacity: $450,000 (property’s value) minus $90,000 (bank’s 20%) = $360,000 (useable equity) minus $220,000 (mortgage balance) = $140,000

Leaves us with an accessible equity of $140,000 (the amount you can borrow)

Leaves us with an actual owner’s equity of $230,000 (the amount you will receive from the proceeds of a sale*)
Why is it so important?

This accessible equity can be used as a deposit on an investment property. The equity can be used to put down a deposit on your next investment property, to cover legal costs and stamp duty.

Accessing your equity

The most straightforward way to setup your debt is to us a loan called a Line-Of-Credit. This keeps the debt secured to just one property, but you can take the cash from the Line-Of-Credit to put down as your deposit on your next purchase.
At settlement the new mortgage is drawn down to cover the remaining cost of the property purchase.
And the process just keeps working. The faster a property increases in value the sooner the equity can be accessed to purchase another property. This rise in value is the golden egg that all property investors are looking for.

Equity can be generated by both an increase in the market value of the property and through a decrease in the amount owed on the mortgage.

* less selling costs, etc.

• This reply was modified 10 years, 2 months ago by  Modernity Investing.
• This reply was modified 10 years, 2 months ago by  Modernity Investing.
• This reply was modified 10 years, 2 months ago by  Modernity Investing.