As a homeowner, you may be able to build your wealth by investing in a second property without having a deposit.
Once you’ve bought your first home, you’ve already made a big step toward building your wealth. You may still have a lot of your mortgage to pay off, but you’ve acquired a valuable asset that you can use to your advantage. As the equity in your home grows, you’ll eventually get to the point where you have enough to purchase a second property without having to save up for another deposit.
Find out how purchasing an investment property with your home’s equity works, and then decide if this path is something you may be interested in pursuing.
What Are the Advantage of Investing in Property with Equity?
There are many reasons people decide to go from being a property owner to a property investor. By using your home’s equity, you can access an investment property a lot faster than you could have done if you'd had to save up for a deposit.
When you purchased your first home, you probably spent a long time saving enough money for a downpayment. Putting together even a 5% or 10% deposit can take years with median home prices in Australia sitting well above $400k. Instead of spending years saving for another deposit whilst paying down your mortgage and meeting your other financial obligations, you can use your property as the asset to secure a loan.
Here are a few situations in which using your equity and buying a second property without a deposit is a smart strategy:
- You don’t want to wait to save for a deposit because home prices could increase, making it even more expensive to purchase a second property later on.
- You don’t want to have to tap into your own savings – this will leave you with more liquid capital to work with for other needs, whether you want to take advantage of another timely investment or use your savings to renovate one of your properties.
- You are an experienced house flipper, or want to become this type of investor, using equity allows you to buy a property quickly when market prices are low or when you find a good deal. Then you can sell the property for a better price and earn a good return from your investment.
How Does an Equity Loan Work?
When you use an equity loan to buy a second home, you’re tapping into your home equity to make a property investment. Your equity is the difference between what you owe on your loan and the value of your property.
As an example, if your home’s current value is $650k and you have $350k left to pay on your loan, you would have $300k ($650k-$350k) in equity.
Keep in mind; your equity is based on the value of your property now, not the original purchase price.
How Can I Quality for an Equity Loan?
As you may have guessed, you’ll have to live up to high financial and credit standards to qualify for an equity loan and buy another property. Your bank will want to feel confident that you can handle the increase in debt.
You’ll have to have a perfect repayment history with your current mortgage.
You need to have excellent credit – there shouldn’t be any issues on your credit file like overdue or late payments. Also, ideally you haven’t applied for credit recently.
You can’t owe more than 80% of the property value for your current loan. The more you’ve paid off and the lower your current loan-to-value ratio (LVR), the easier it will be to qualify for an equity loan.
When determining how much you can afford, keep in mind, you’ll only be able to access 80% of your current property value in equity in most cases. If you have enough equity built up, which is more likely if the value of your property has increased and you’ve had time to pay down a chunk of your mortgage debt, it’s possible to buy a second property without having to save for a deposit or take out a personal loan.
If you want to learn more about your eligibility for an equity loan, contact us today for a free assessment. You can also call (07) 3146 5732 to talk with one of our mortgage specialists.
Methods for Using Equity to Invest in Real Estate
There are different ways you can use your equity to purchase a second property without a deposit.
As long as you have plenty of equity, you may be able to access enough money to use as a deposit for a second mortgage. Lenders will usually allow responsible borrowers to draw down a set cash amount.
One thing to keep in mind with this strategy is that banks tend to set cash out limits at $50k or less. You may still need to use some savings to cover the full deposit along with purchasing costs. You’ll also need to demonstrate that you’re using the money to help buy real estate. You can do this by presenting a letter from your conveyancer explaining that you’re searching for a property or with a copy of your contract of sale.
Line of credit loan
Another way to unlock your home equity is by refinancing to a line of credit loan. You don’t have to switch lenders to do this. What you do need is to be in a strong position to make this move – which means having clean credit and enough equity.
The advantage of a line of credit (LOC) loan is its flexibility. You can use up your LOC borrowing limit to cover your deposit so you can purchase an investment property. You may also be able to use your LOC facility to cover purchasing costs. You can even use it to pay for any renovation work or improvements your investment property would benefit from. The downside is, a LOC loan will have a higher interest rate than a standard home loan, which will increase your overall borrowing costs. On the other hand, line of credit loan interest rates would likely be significantly lower than the rate for a personal loan.
In this case, you are putting both your current property and your investment property into one mortgage. You’ll use your existing property as the security for the loan – which means you’ll need to have enough built-up equity to make this type of equity financing work.
Because of the pressure from the Australian Prudential Regulation Authority (APRA), banks are more restrictive than ever before with investment lending so expect to have a lot of equity and a low LVR for cross-collateralisation.
With this type of financing, you won’t have as much flexibility as you’d have with a LOC loan. Also, you might not be able to invest in more property in the near future, especially if the value of even one of your properties goes down. Because of this, cross-collateralisation may not be the best strategy if you plan on buying more than that second property. The advantage of this approach is, you’ll have a lower interest rate.
Making It Easier to Qualify
The reality is, you don't have to be an all-star borrower to qualify to use your equity to buy a second property without a deposit. If you want to grow your wealth with real estate, everything you can do to reduce the risk to your lender will increase your chances of qualifying for the type of equity financing that fits your investing plans.
The more built-up equity you have, the better. You may not be able to control the price movements in your local area, but you can increase your equity by paying down your home loan faster. If you plan on investing in the future, consider making extra repayments on your mortgage and using an offset account, if your loan has this facility.
Save for part of the deposit. It may not make sense to pour all or a majority of your liquid resources into a deposit for a second property but saving part of the deposit can certainly help your case as a borrower. Not only would you need to unlock less equity, but you’ll also demonstrate to your lender that you’re capable of budgeting and saving money whilst managing your current mortgage payments.
Know how much you are comfortable borrowing and decide the best equity loan for you. Another way to increase your chances of qualifying – and of having a successful experience as a property investor – is to make sure you can handle the extra debt and that the advantages of buying a second property outweigh the risks.
Our mortgage experts can offer fantastic insight into the options available for creating your plan for repaying your home loan debt and for getting the most out of your investment.
You can also speak to one of our mortgage brokers who specialise in property investing. Contact us today for a free assessment! Fill out our online enquiry form or call (07) 3146 5732 to get started.