I just read chapter 8 (the bonus free chapter) of the new 0 to 260+ properties in 7 years, and have a question:
It suggests that the equity in a property bought for 200K and valued at 250K after 2 years, with 50K debt reduction will have an euquity of 100K. I understand the maths behind this but cannot see how the ‘equity’ of 100K is any better than the house price rise of the 50K.
Simply put net value of my position has only changed 50K due to the house price increase. Not becuase of the debt reduction.
What am I missing? [blink]
equity is important because it allows you to use the greater amount of equity to purchase more houses. The way the banks work is generally they will lend you 80-95% LVR. So for instance you have the $200K and paid of the 50K with no growth in value then your LVR is at 75% however if its gone up 50K to $250 then your LVR is at 60%. If you bought another house with using only 50K equity it would probably push your LVR over 80% which means you would have to pay the LMI fee, whereas if you had 100K equity you wouldnt have to pay this fee.
correct me if im wrong anyone
Smifter, I would agree with you that your investment position has only increased by $50k, the other $50k debt reduction is from cash paid off the loan, so whether you pay it off the loan or invest that cash you’ll still have $50k more than you had at the start. So really, it’s only the property value increase that has increased your net wealth.
from an accounting viewpoint as steve is an accountant
Equity = Value of property minus debt owed
Equity = original value plus increase in value minus debt
Equity = $200,000 + 50,000 – 150,000
Equity = $100,000
This is also know as your financial position from accounting
To a bank you have $100,000 to use to borrow more money
Also if interest rates increase or you lose your job you are $50,000 ahead of your loan repayment schedule which gives you some breathing space…Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
Not putting a stick in the spokes…..but regardless of whether the true answer is 50 or 100k, remember by far the majority of lenders require you to be able to service the loan when borrowing, making equity almost irrelevant. and everytime you ‘refinance’ your other loans are more often than not viewed as principal and interest even if interest only, with the alternative being to cross secure your properties, which while easier and on paper ‘cheaper’ often results in a whole new series of problems if you ever want to sell. That being said, if you earn a squintillion, have a great line of credit already to allow for low LVR purchasing, or get heaps of rent via CF+ properties, it does not take long to ‘run into a wall’ regardless of equity. Still, net wealth is way up, as everyone has mentioned. Trajik is on the money as far as the end results of your scenario though. Now that I have typed this, I think I should have posted it somewhere else, but the whole equity thing is not the b all and end all for many. [thumbsupanim]
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