Good day folks!
Still very new to all of this but am keen to get into investing (property, shares etc). 'Equity' is a word that seems to get thrown around quite a bit and I've started to get into a couple of books that talk about the use of equity in a currently-owned property to purchase another. I had a long discussion with my parents on 'equity' and still can't make adequate sense of it, so I thought to pose the question here. For the sake of examples, let's consider the following:
Let's say I current own one property, Property A. Property A is currently rented out. Details:
Purchase price: 450K
Loan: 360K, interest only, linked to a 100% offset accountAfter owning Property A for two years, let's say the market value is now 470K. That leaves me with equity of 110K. From what I've read, it's then possible to draw out 80% of this equity, or 88K.
I then see Property B which I want to buy:
Price: let's say, 450K
Loan: similarly, I wish to take a 360K loan, interest only, and linked to a 100% offset accountLet's assume also that my income would be able to service the loan on both houses and both are rented out, and I also have sufficient deposit for Property B.
Where does the use of the 88K of equity come in? Is it simplistic to assume I can put this money into Property B and hence take a smaller loan instead? What are the costs involved in the use of equity? My parents seem to think that I would still need to pay the bank interest on that 88K. Is this correct? What then is the advantage of using equity from Property A to pay for Property B, other than having extra cash in the offset account?
Hi F
In essence you can use upto 90% of the available equity so in the scenario above with equity of $110,000 then you would be able to borrow against $99,000 (ignoring the LMI costs of doing so).
The 9K is however a separate loan and therefore incurs interest however one advantage of structuring the loan this way is that the loans are separate and therefore not cross collateralised.
Richard Taylor | Australia's leading private lender
Qlds007 wrote:…the loans are separate and therefore not cross collateralised.Sorry, what's the significance of this? Does it mean that the bank can foreclose on Property B and not Property A when I can't make the repayments?
So from this I gather the following:
– instead of using 90K of my savings as a deposit for property B, I can use 88K equity (no LMI) from Property A for the purchase
– I end up with two separate loans, one for 88K on Property A and 360K on Property B
– this results in me having 88K cash in the offset account to offset the loan on Property A
– essentially, the only advantage to using equity is just to have free cash ready for something else.If this is the case then I don't see a huge advantage to using equity from Property A. I might as well use all my savings as deposit on Property B, have next to nothing in my offset account and be able to negatively gear both properties to the max. Is this the way to work? Why should I use equity from one property to fund another? This is something that seems advocated by some who talk about 'buying property and never selling', instead drawing equity from property each time.
If you are unsure about the begativs of cross collateralising your loans i think you should read some of the past post both Terry and i have written.
If you use your own cash as a deposit remember you wont be able to have it back again and claim the interest as a Tax deduction. Most people want to keep their cash flexible as you never know when you might need it.
Richard Taylor | Australia's leading private lender
Qlds007 wrote:If you use your own cash as a deposit remember you wont be able to have it back again and claim the interest as a Tax deduction. Most people want to keep their cash flexible as you never know when you might need it.
That's a good point. Better cash in my hand than somebody else's. I was just a little hopeful that using my own equity would be cheaper than taking out a loan for a similar sum of money.
When you use the equity in property A just think of it as borrowing from property A to fund property B.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Just to clarify:
If fWord has a house worth $470,000, and a loan of $360,000, can he borrow 90% of the equity or 90% of the total LVR?
If he borrowed $99,000, he would have loans of $459,000 and val of $470,000; LVR of 97.7%.
Is this correct?
Point take Dan
To correct –
F could borrow 90% of his current valuation = $470,000 x 90% = $423,000 – existing loan of $360,000 gives $63,000.
Richard Taylor | Australia's leading private lender
Thanks Richard.
Terryw wrote:When you use the equity in property A just think of it as borrowing from property A to fund property B.Thanks for the response. However in this case I understand that I have to pay interest as with any other loan. As such, is there any real advantage to drawing out equity instead of just borrowing from the bank? The bank would certainly look at my ability to service the loan while considering how much equity to allow me to draw upon. So, if I didn't have enough deposit for Property B in the first place, can I realistically still rely on Property A to fund part of my deposit?
Again this assumes I don't want to loan any more than 80%.
Qlds007 wrote:Point take DanTo correct –
F could borrow 90% of his current valuation = $470,000 x 90% = $423,000 – existing loan of $360,000 gives $63,000.
Thanks for the clarification of this. It's a good ballpark figure that I can work with for now.
fWord wrote:Terryw wrote:When you use the equity in property A just think of it as borrowing from property A to fund property B.Thanks for the response. However in this case I understand that I have to pay interest as with any other loan. As such, is there any real advantage to drawing out equity instead of just borrowing from the bank? The bank would certainly look at my ability to service the loan while considering how much equity to allow me to draw upon. So, if I didn't have enough deposit for Property B in the first place, can I realistically still rely on Property A to fund part of my deposit?
Again this assumes I don't want to loan any more than 80%.
Yes, you will have to pay interest on all borrowed money. But what is the alternative?
if you cross collateralise you will be in a worse situation, security wise, and have a messy problem in years to come. You will also be borrowing more (same as my method) so it will cost you the same.
If you use cash, that is cash which could have gone off your PPOR loan which could have saved you non-deductible interest. It will also take time to keep saving for cash deposits.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Terryw wrote:Yes, you will have to pay interest on all borrowed money. But what is the alternative?
if you cross collateralise you will be in a worse situation, security wise, and have a messy problem in years to come. You will also be borrowing more (same as my method) so it will cost you the same.
If you use cash, that is cash which could have gone off your PPOR loan which could have saved you non-deductible interest. It will also take time to keep saving for cash deposits.
So if I were to draw equity from Ppty A for Ppty B (when the time comes), should I simply tell my broker to 'draw it out in cash' or 'not cross-collaterise'?
I'm actually lucky because once I start renting out Ppty A, I will be living with parents and hence no PPOR loan. They might charge me rent, but I will have no loan per se.
Thanks again.
its not a matter of just telling your broker. You need to apply and set up another loan on property A in advance (ideally) of starting the loan for property B
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Terryw wrote:its not a matter of just telling your broker. You need to apply and set up another loan on property A in advance (ideally) of starting the loan for property BThanks for the advise. Let's say I take a loan of $60K on the equity from Ppty A. Does the $60K then sit in my offset account until ready for use (ie. incurring no interest until I use it as deposit for Ppty
? Are there substantial charges incurred for taking a loan on equity? The plan at the moment is vaguely: revalue Ppty A in the next 12 months, take the loan on equity as you said, then with what I have start looking for the next ppty.Yes I probably should be speaking to my broker about all these things, but want to get as much knowledge as I can before taking the next step.
Don't borrow money and put it in your offset or the interest may not be deductible.
Set up a LOC and have the $60k undrawn and sitting there waiting to be used.
Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
? Are there substantial charges incurred for taking a loan on equity? The plan at the moment is vaguely: revalue Ppty A in the next 12 months, take the loan on equity as you said, then with what I have start looking for the next ppty.You must be logged in to reply to this topic. If you don't have an account, you can register here.
