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Buying a second home with equity
Turn the equity in your home into income by investing in property.
If you’re an owner-occupier looking to invest in property, you can leverage your existing home to build your property portfolio — but you could risk losing one, or both, homes if you aren’t financially stable.
What is equity?
Equity is the difference between your home’s value and the amount you owe on your mortgage. For instance, if your home is valued at $750,000 and you owe $500,000 on the loan, you have $250,000 in equity.
Equity increases in two ways. First, you build equity by making your regular principal and interest repayments. The more you pay down the principal of your home loan, the more equity you create.
The second way equity accrues is through your home rising in value. If you paid $650,000 for your home and it’s currently valued at $700,000, you would have accrued $50,000 in equity through capital growth.
How can I use the equity in my home?
Lenders will allow you to borrow money against the equity you have in your current home and use it as a down payment for a second home. Before you do so, you need to decide which loan structure best suits your circumstances and property goals.
One way to tap into your home’s equity is to refinancing. Your home will be revalued and a lender can then refinance your home loan based on its new value and allow you to withdraw cash equivalent to the equity that’s built up. Keep in mind that if the value of your home goes up, the larger mortgage will mean higher monthly payments and more interest charges.
Home equity loan
Another way to unlock equity is through a home equity or line of credit loan. This is a separate home loan that extends you an amount of credit based on the equity in your property. You can use as much or as little of the credit limit as you like, and you’ll only pay interest on the amount you use. This can be a tax-effective strategy for investing in property because it maximizes your tax-deductible debt by allowing you to make interest-only payments.
How can I boost my borrowing power?
It’s unwise to borrow more than you can comfortably afford to pay back. But if you’ve budgeted well and have a clear idea of the amount of debt you can handle, there are a few steps you can take to boost your borrowing power.
One of the most effective ways is to minimize your existing debt. Consider whether you can afford to take some time to pay down any existing credit cards, personal loans or car loans before you apply for a new mortgage.
If you can, consider making extra payments on your existing mortgage. Any amount you pay above your minimum payment will go towards paying down the principal of your loan. By doing this, you’ll build up additional equity you can borrow against.
Income vs. debt
Before you invest in a property, make sure you do your research to determine how much rental income you’ll be able to generate versus the expenses of managing the property and servicing your new debt.
If you can manage the cost of your mortgages and the running costs involved with the investment property, using your equity to build a property portfolio can be a financially savvy decision. Just make sure you won’t be over-extending yourself before you decide to invest.
Build in a safety net
The most important way you can mitigate the risk involved in borrowing for an investment property is to build in a cash buffer.
A cash buffer helps you cover periods when the rental income you receive from your investment property fluctuates. This could be due to untenanted periods or financial hardship on the part of your tenants.
It can also serve as an emergency fund in the event of unexpected repairs. While some repairs can be claimed on insurance, a cash buffer will help you get repairs underway while you wait for your claim to be processed.
In addition, the buffer will serve as a safeguard in the event of a rise in your expenses. If you have a variable rate home loan, your rate and monthly payments could increase at any time. A cash buffer helps alleviate the pressure from rising expenses and gives you time to respond, either through better budgeting or increasing your rental income.
Using your equity to invest in property can be a great way to build wealth. But before you invest in a new mortgage, take into account your current financial circumstances and ensure you’ve budgeted wisely — and have enough cash on hand to cover anything you couldn’t budget for.
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