Using Your Equity Funds
Budget: Get a pre-approval from a lender for the investment property. This is a VERY important step in the process, because:
- Youll know what you can afford
- Pre-approval letter strengthens your offer, because it shows the seller that you are serious and have the means to close.
- Your loan will likely close quicker because the lender is already through a big part of the loan approval process.
Plan on having 15%-25% or more of the purchase price set aside for a down payment and closing costs.
What Should I Consider Before Accessing Equity For Property Investment
While leveraging the equity in your home to invest in a second property may sound like a great idea, there are several factors to think about before diving in.
The most important: make sure you can manage the extra repayments and costs that come with an investment property, especially if your property is negatively geared. Think about your cash flow and make sure youll be able to stay on top of things with your new repayments. You may find yourself managing different loans with different repayment amounts, schedules and loan terms organisation is key.
Having a solid investment strategy and doing your research is also important. Long-term investment is a more reliable strategy, compared to short-term property investment which can be risky. You want to avoid a situation where the property youve purchased is overvalued and youre left with negative equity.
Remember that every method of using equity to purchase an investment property comes with a substantial risk: if you default on any of your loans, you could lose one or multiple assets. There are also tax implications to consider, so make sure you speak to an expert before you make a decision.
Before making the decision to access your usable equity, its a good idea to weigh up all the options, consider professional advice and decide whats best for you and your financial situation.
Use Your Equity As A Deposit On An Investment Property
This is one of the better-known uses of equity. If you’re looking to purchase an investment property, you can avoid the deposit-saving process by using the equity in your existing place.
Your lender will request a valuation to assess your propertys fair market price. This valuation will then be used to determine what your usable equity is.
Just because you have $200,000 in equity, it doesn’t mean you can access it for this purpose. Lenders will also consider your income, number of children, your general living expenses, debts and other factors. They will typically release up to 80% of your equity, subject to serviceability in the case of our example, $160,000.
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How Much Equity Do You Need
Lenders are typically happy to lend up to 20% of a homeâs value without lenders mortgage insurance . So, your usable equity is the total equity you own minus the 20% of the value of your home.
For instance, in the same scenario your usable equity would be:
$400,000 = $400,000 $150,000 = $250,000
That means, in this scenario, you may be able to borrow as much as $250,000 to buy an investment property. Depending on your lender, by taking out LMI you could potentially borrow even more.
The Value Of Your Home Can Decline
Keep in mind that theres no guarantee that your home value will increase substantially over time. Your home may even lose value in times of economic downturn or suffer damage from fire or extreme weather.
If you take out a home equity loan or HELOC and the value of your home declines, you could end up owing more between the loan and your mortgage than your home is worth. This situation is sometimes referred to as being underwater on your mortgage.
Say, for example, that you owe $300,000 on your mortgage but the home prices in your area tanked, and now the market value of your home is just $200,000. Your mortgage would be $100,000 more than the value of your home. If your mortgage is underwater, getting approved for debt refinancing or a new loan with more favorable conditions is much harder.
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Home Equity Loan Risks
Home equity loans are loans that allow you to borrow against your homes equity for a lump-sum payout that you pay back over time with a fixed interest rate and fixed monthly payments. They carry two main risks:
- You could default on your loan and lose your home if you cant keep up with payments.
- Your homes value could decrease and you could become underwater on your loans, meaning that you cant move or sell your home without paying money to your lenders.
Theres A Limit To How Much You Can Borrow
Theres also a limit to the amount you can borrow on a HELOC or home equity loan. To determine how much money youre eligible for, lenders will calculate your loan-to-value ratio or LTV. Even if you have $300,000 in equity, most lenders will not let you borrow that much money.
Lenders generally allow homeowners to borrow up to 80 percent to 85 percent of the value of their homes, minus existing mortgage balances. That number can differ from person to person, though, and depends heavily on your credit score, financial history and current income.
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Beware Of The Traps When Accessing Your Equity
Using the equity of your own home to buy an investment property carries some risks. If you dont use your equity wisely, you could end up losing your home. Or worst, you could lose both your home and your investment property.
Here are some tips to help you maximise the power of your equity safely:
- Make sure you maintain a sufficient buffer. If you dont have spare funds aside from the equity in your home, dont use all of it to invest in property. This will help you prevent having to borrow money in the event of an emergency.
- Repay the home loan on your home as fast as possible before focusing on the investment. This way, youll have access to more equity and can use it if needed.
- Educate yourself about investing in property. Its a huge financial commitment so ensure you pick a good property in a high growth area.
- Speak with a professional financial advisor to understand your options. They can help you understand how much equity you can access and if using equity to buy an investment property is a viable option for you.
Please note that the above must not be taken as financial advice. This is general information only and you should seek out relevant and independent professional advice before making a financial decision.
Should You Cross Collaterise
According to loans.com.au Product Manager Tiska Sudarmana, cross collaterisation has its risk but can provide certain benefits under the right circumstances, such as minimised fees.
The equity of your current property is used as security for loans on both this property and another property. So if you can’t pay off the debt on one property, then both properties could be repossessed.
However, there are some cases that permit cross collaterisation. For example, the debt on your current property might be too high to allow traditional refinancing.
If you will be able to pay off both mortgages and perhaps have good knowledge of the property market, then this could be an option – but be aware of the risks.
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How To Find A Lender For An Investment Property Heloc
The best way to find a lender for a HELOC on investment property assets is to leverage your existing network. This is because not all lenders will grant HELOCs for investment properties, making them somewhat tricky to find. Investors should ask mentors and other connections to learn more about HELOC providers. Be sure to consult your most recent lender, whether that be a traditional bank or otherwise, to learn if they know of any options. There will likely be a few potential lenders to choose from, allowing investors to choose from the best approval requirements and interest rates.
Aside from word-of-mouth referrals, investors can also research lenders online or contact previous connections to see what options are available. While it is easier to find HELOC providers for a primary residence, lenders are willing to do the same for investment properties. Often, smaller banks or credit unions are more likely to provide HELOC loans. Search online and be sure to confirm that they finance investment properties.
It’s All About The Cash Flow
With rates this low and over 50% equity in my home, the timing could be right to leverage that equity to buy my first investment property. Once the new property is paying us optimal rents each month, I can refinance the property with its own mortgage, take most of our money back, and pay off our home equity loan.
If that all works as planned, I will end up making money every month from our investment property going forward. If I make a good buy, it could also go up in value, which would be great if I ever decide to sell.
Just like the back of a shampoo bottle, I can repeat the process again if it works well. Each time, I will increase my family’s monthly income without dramatically increasing our workload. That’s a financial win in my book.
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Why Maximize The Value Of Your Home Equity
Home equity, in simple terms, is the money your home is making for you. As the property you bought appreciates over the years, it becomes worth much more than what you paid for it. Even if you dont want to sell it, you can still use the value it has generated over a period of time to purchase a second home. You can use your homes appraised value to make the down payment for another property, be it a vacation home, a second home, a rental property or otherwise. Using the equity in your home to invest in real estate and generating more returns makes more economic sense than simply letting it sit around and allowing that added value go to waste.
Some people use home equity to buy a second home in Canada or vacation home for recreation while others do it for investment purposes. In any case, before you actually use your equity, its important to carefully weigh your options, whether youre buying a vacation home or a property to generate a steady stream of rental income. If you are looking to buy a rental second property, remember that a condo will give you the highest returns on your investment. Currently, scarcity in the housing market has led to low vacancy rates, which in turn has led to a good appreciation of condos . No matter what type of housing option youre considering, be sure to get an estimate of the price of the property youre looking to buy with the equity in your home. Next, we deep-dive into the topic by taking a closer look at some of the equity terms.
How To Get A Home Equity Loan To Buy Another House
If youre interested in using home equity to purchase a new home, the value of your house will need to be high enough to support the loan, and youll have to meet your lenders requirements. Heres how to get a second mortgage to buy another house.
1. Determine the amount you want to borrow. Before taking equity out of your home to buy another house, decide how much you want and need. Home equity loans limit how much you can borrow. In most cases, you can only access up to 85% of the equity in your home. For example, if your home is worth $350,000 and you owe $250,000, you have $100,000 in equity. In this example, the maximum you would be able to borrow is $85,000.
2. Prepare for the application process. Your approval for a home equity loan will depend on multiple factors. The value in your home will determine the maximum amount of equity available, and your financial information will determine how much of that equity you can borrow. In addition, your lender will look at your credit score, income, other outstanding debts and additional information.
4. Apply to the loan with the best terms. Once you’ve determined the loan with the best terms, youre ready to apply. Youll submit the application and provide the requested information. Your lender will order an appraisal of the home or determine the value using another method.
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Using Home Equity To Purchase A Second Home Or Investment Property
It may be tempting to turn all of that untapped capital into a vacation home or investment property. While the advantages of using a home equity loan might seem overwhelming, itâs important to weigh both the pros and cons before following through on that transaction.
Pros
- Lower interest rates: Home equity loans generally have lower interest rates than other types of financing because your primary residence serves as collateral for the loan.
- Larger down payment: The cash you receive from your home equity loan can help you put down a larger down payment or turn you into a cash buyer and make your offer stand out in a competitive market.
- Easy to qualify: Getting a mortgage for a second property can be difficult, and home equity loans are generally easier to secure.
Cons
Advantages Of Using Equity To Buy Another Home
Many investors use equity in their existing properties to purchase more investment properties, which enables them to build a bigger investment portfolio. By using existing equity to buy more properties, you can get into the market at today’s prices and reap the rewards of price growth than if you had waited and saved the deposit, which can take years.
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Is It A Good Idea To Get A Heloc For My Investment Property
Whether its a good idea to get a HELOC for your investment property depends on your individual circumstances, financial goals, and intended use for the HELOC.
A HELOC in general could be a good fit if you want a flexible, ongoing source of financing that you can tap into for virtually any purpose. However, make sure youre comfortable with the variable-rate structure of a HELOC, which can cause your rate and monthly payment to unexpectedly change in the future.
Your Home Equity Loan Interest Payments Will Likely Not Be Tax
In 2018, changes to tax codes led to somewhat ambiguous guidelines for investment properties. Because of this, we recommend consulting with an accountant before making any decisions. However, if the home equity loan is not specifically being used to improve the property it was taken out against, its likely it will not be tax deductible.
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Primary Loan Vs Heloc
A primary loan refers to a traditional mortgage taken out to purchase a new property, while a HELOC on an investment property taps into existing equity. To effectively compare the two options, there are a few main differences to consider.
For example, investors tapping into existing equity may find this option to be more costly when compared to a traditional mortgage. As I mentioned above, the reason for this is because HELOCs on investment properties are generally considered to be riskier than those on primary residences. Some lenders may require multiple appraisals or longer waiting periods before approving a HELOC. Investors may also find they can secure lower interest rates when compared to a mortgage.
This is not to say a primary loan is necessarily the better choice compared to a HELOC on an investment property. Investors can and do tap into their existing equity all the time, despite certain trade-offs being involved. Just remember to carefully weigh the pros and cons of each option before making a decision.
What Is A Home Equity Loan
A home equity loan is a type of fixed-rate loan thatâs secured by your home. You can generally borrow up to 80% of your homeâs equity through a home equity loan, depending on the lender.
Unlike with a home equity line of credit that allows you to repeatedly draw on and pay off your credit line, youâll receive your home equity loan funds as a lump sum. Youâll then pay this amount back in equal installments over your repayment termâusually five to 30 years, depending on the lender.
Because a home equity loan is secured by your house, itâs seen as less risky to the lenderâso they tend to offer a lower interest rate compared to other types of loans. Your rate will also depend on other factors, such as your credit, income and debt-to-income ratio.
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Can You Use A Home Equity Loan To Make A Down Payment On A Home
Yes, if you have enough equity in your current home, you can use the money from a home equity loan to make a down payment on another homeor even buy another home outright without a mortgage. Note that not all lenders allow this, so if youre planning to buy the second home with a mortgage, you may need to shop around to find one that does.
Using Equity : How Does Equity Work
Accessing the equity in your loan is easy. With a simple mortgage refinance, you can be steps closer to buying a second home. Using equity in an investment property to buy a home works pretty much the same too. The equity from your home or investment property can be used as a deposit on a second property, while your current property becomes a security on the new debt. Using equity allows you to buy a second property with no cash deposit.
Managing Director of loans.com.au Marie Mortimer has seen many borrowers use their equity to purchase an investment property.
“After you’ve had your loan for a few years, it’s important to recalculate your equity and understand the different ways you can increase the equity in your home over time.”
“Our customers often reduce their loan balance by either making principal and interest repayments or making extra loan repayments, or even an offset sub-account.”
“Another way is when the property value goes up, either by holding the property for a period of time, or making improvements to the property,” Ms. Mortimer said.
When the value of your home rises, the equity does too. A home’s value may rise because of capital growth or dedicated mortgage payments. You could also increase the value in your home by making renovations .
Your lender will calculate your loan to value ratio to ensure some equity is held as security. After this, you can determine how much equity you have after refinancing.
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