Using equity to buy an investment property
It sounds like a dream deal: buy a second house without a big bank account. Is this really possible? Using the equity on your first property, it is. It’s a smart move that many people have benefited from but as a real estate agent, we suggest you consider all the pros and cons of equity purchase, sooner rather than later.
What is equity?
Equity is the difference between the current value of your house and all the cash you still owe your lender. Think of it this way – your house is valued at $600,000 and you’ve paid $400,000 off the mortgage. As a result, you have $200,000 of equity wealth to potentially snap up a second investment property. Sound tempting? Wait, there’s a lot more to it. This $200,000 of “accessible” equity is very different to your “useable” equity. You can only borrow 80% of your property’s current value (here’s where you’ll need a current valuation report) minus your mortgage and any other debts you have. In this case, your useable equity gives you $80,000 to buy another house. While not as significant as $200,000, it will make a big difference to your second purchase.
Dream deal as it may be, using your equity to buy another investment property can be risky business. If you aren’t smart about this next move, you could end up losing both your residence and your rental. Firstly, while your calculations can appear exciting, don’t pour every cent of your equity into that great new house. Ensure you have a good financial buffer of back up funds, well outside of your home equity, for any emergencies that crop up (and they will). Your equity will increase with your property’s market value but instead of waiting for this to happen, focus on paying off your home loan ASAP with extra repayments and similar. The faster you do this, the more equity you’ll have and sooner. Your cash flow should be solid and remember to research details such as your potential rental income and investment property expenses. Then there’s the tax implications. Second homes are essentially tax-effective, including equity used or drawn from your first home to purchase another – but this isn’t the case for that same first home. As always with large financial possibilities and opportunities, research and expert advice is key to a strong outcome.