Using Equity to Expand Your Property Portfolio.
If you're a homeowner, you may be sitting on a pot of gold. Over the years, your home may have increased in value, and you may have paid down some or all of your loan, resulting in home equity. Home equity is the difference between your property's value and the amount still owed on its mortgage.
Depending on how long you've owned your home, you could have a significant amount of equity that you could use to build your investment portfolio. In this article, we'll explore how you can use home equity to fund an investment property and the things you need to consider before doing so.
Understanding Equity
Equity is the difference between a property's current market value and the amount of money you still owe.
Imagine you purchased a property for $1,000,000. Over time, your outstanding mortgage falls to $600,000, while the property's value, due to market appreciation, rises to $1,500,000. In this scenario, you've amassed $900,000 in home equity ($1,500,000 - $600,000).
This equity isn't just a theoretical value; it's a powerful tool that homeowners can harness for various purposes, including upgrading your home, kickstarting a business, or purchasing an additional investment property.
Usable Equity
While having equity is great, it's crucial to understand that not all equity is usable or accessible. The term 'usable equity' defines the portion of your home's equity you can tap into and utilize for other investments.
Banks and lending institutions generally allow homeowners to borrow up to approximately 80% of their home's current market value. This is due to the financial risks associated with property value fluctuations.
Let's take the previous example. Your home is now valued at $1,500,000. If a bank permits you to borrow up to 80%, this amount would be $1,200,000. If you subtract your existing debt ($600,000) from this, you'll have $600,000. That's your usable equity.
Why only 80%? Lending more than this often entails the need for Lenders’ Mortgage Insurance (LMI), designed to protect the lender in case you default on your loan. This could also attract extra charges around 2-3% of the loan amount and potentially higher interest rates.
Equity is a potent weapon in a savvy homeowner's arsenal. By understanding it, you can leverage it to grow your wealth and achieve your financial goals. Just remember, every strategy comes with its risks, so it's always advisable to consult with a financial advisor before making significant investment decisions.
How Can You Access Your Home Equity?
Once you've crunched the numbers and concluded that leveraging your home equity is a viable option, the next logical query is how you can access this equity. You have several choices, each catering to different needs and circumstances:
Equity Line of Credit
An Equity Line of Credit offers you a certain credit limit based on your usable equity. You only pay interest on the portion of the credit that you use, providing flexibility for your financial goals.
Full Access to Equity
Accessing your equity in full offers you the complete amount of your usable equity. However, keep in mind that this approach increases your mortgage, and subsequently, the interest payable on the new larger mortgage balance.
Collateral-Based Loan
A collateral-based loan uses the equity from your existing property as security for a loan that encompasses it and your new property. This means your loans are interconnected instead of releasing equity for a down payment on another property.
While this strategy can provide more borrowing capacity, it comes with a caveat. If you default on the loan repayments, the lender could legally take possession of both properties. Therefore, pursuing this option should be done cautiously and ideally with professional financial advice.
Harnessing the Power: Common Uses of Home Equity
Home equity, the hidden wealth accumulated in your property, can serve multiple purposes, depending on your financial needs and goals. Here are some of the most common uses of home equity:
Home Improvements and Renovations
One of the most popular uses of home equity is to fund home improvements or renovations. This could mean anything from minor touch-ups to major structural changes. Renovating your home not only enhances its comfort and aesthetics but can also boost the property's market value.
Investment Properties
Home equity can also act as a stepping stone towards expanding your property portfolio. Many homeowners leverage their equity to secure a down payment for an investment property, building a pathway to passive income and long-term financial growth.
Debt Consolidation
Another common use of home equity is consolidating higher-interest debts into a single, lower-interest payment. This could include credit card debts, personal loans, or car loans. By consolidating, you could potentially save thousands in interest payments and simplify your financial management.
Business Ventures
For aspiring entrepreneurs, home equity can provide the necessary capital to kickstart or grow a business. Instead of applying for a business loan, which might come with higher interest rates, tapping into home equity can offer a lower-cost alternative.
Education Expenses
Finally, some homeowners use their equity to finance major life events or expenses, such as children's education or weddings. This could provide a means to cover these costs without draining savings or resorting to high-interest personal loans.
Remember, while these opportunities can be lucrative, it's essential to seek professional advice to understand the risks associated with each option fully.
Leveraging Equity for Investment Property: The Smart Move
When you use equity to purchase an investment property, you're essentially using your existing home as collateral to secure another loan. The bank assesses the usable equity in your home and lends against that amount for the deposit on the investment property. With the potential for property values to increase over time, this could lead to significant wealth creation.
Securing an investment property can offer potential tax benefits. Interest on the loan and other property-related expenses can often be claimed as tax deductions, thus reducing your taxable income. Rental income from the property can also help cover loan repayments, making it a self-sustaining investment in many cases.
However, while using equity to fund an investment property can be an effective strategy, it's not without risks. You're increasing your debt, and if property values decrease or rental income fails to cover expenses, you may find yourself in financial hot water. It's also important to remember that increased borrowing may lead to higher repayments and longer loan terms.
Cautionary Advice: Understanding the Implications
Before you eagerly reach out to your lender about extracting the equity from your home, it's essential to consider a few cautionary points:
Accessibility to equity doesn't equate to necessity: Just because you have substantial equity doesn't mean you should utilize all of it. Overleveraging can lead to financial stress if the market downturns or personal circumstances change.
Approval depends on various factors: Obtaining a second home loan is not solely dependent on your available equity. Lenders will assess multiple aspects such as your income, number of dependents, existing debt, and overall living expenses. This holistic view of your financial situation ensures you can comfortably manage the increased debt.
Choose your investment property wisely: If you decide to use your equity to purchase an investment property, make a careful and informed decision. The property should have a strong potential for capital growth and rental yield to ensure a positive return on investment.
Seek professional advice: When contemplating significant financial decisions like leveraging home equity, consult a financial advisor. Their expertise can help determine whether borrowing against your equity aligns with your financial goals and how to navigate the process efficiently.
Remember, while leveraging equity can open doors to significant wealth accumulation, it also carries potential risks. Always exercise due diligence and get sound professional advice to ensure a decision that positively serves your financial journey.
How Champions In Real Estate Can Help
Ready to unlock the full potential of your equity and expand your property portfolio? Contact Champions In Real Estate today. Our experienced team offers unparalleled expertise and support to help you make the most of your equity. Don't miss out on partnering with industry champions. Get in touch now for extraordinary property portfolio expansion.
