Finance: Using equity to buy your investment property
Many Australians are now tapping into their “pot of gold” - the equity in their home - allowing them to invest for the future and forge ahead financially.
Tapping into your home equity (or equity from another investment property), is a great launching platform for buying an investment property. Say your home is valued at $500,000, you owe $150,000 on your mortgage (thereby giving you equity of $350,000) you may want to invest a portion of the equity into another property.
Diagram 1 illustrates the financial components of your home:
EXISTING BORROWINGS - represented by the blue section of your home. This loan amount (unless used to purchase an investment property) is not usually tax deductible.
If your home is worth $500,000 and you have $150,000 remaining on your loan, your existing borrowings would represent 30% of your home value.
20% EQUITY - represented by the orange section of your home. This is the safety net that lending institutions like to have as their safeguard against the borrowings on your home.
This is unable to be touched unless you want to pay LMI (Lenders Mortgage Insurance). In this example 20% equity of $500,000 is $100,000.
REMAINING EQUITY (what you’ve already repaid on your loan or gained through capital growth on the property) - represented by the green section of your home.
Diagram 1 shows that the remaining 50% of the value of the home is available to use as security for other purchases. To access this remaining equity to purchase an investment property, there are two options: (A) establish a line of credit; or (B) apply for a standard term loan with a redraw facility or an offset account where the remaining equity amount can be invested until required.
Usually the existing loan and the new portion of the loan would be refinanced; however it is common to split these in order to keep the non tax deductible amount clearly differentiated from the deductible investment amount. Your accountant should be able to help with this.
In this example, $250,000 is 50% of the value of your home available to purchase an investment property.
When you do find the investment property you want to purchase, you can fund the acquisition with:
(A) A new loan for the investment property (typically 80% of the purchase price to
avoid LMI). This $400,000 loan (based on a $500,000 investment property) is represented by the grey section of the investment property in Diagram 3.
Plus: (B) Part of the green remaining equity in your home. The remaining 20% of the purchase price (usually representing the deposit) plus stamp duty, conveyancing costs and other associated expenses can be taken from this equity.
In the example it would require you to draw $120,000 (assuming $100,000 [20% deposit] and $20,000 [5% total acquisition costs*]) of the available $250,000 (represented by the yellow section in Diagram 2) leaving $130,000 of the remaining equity. This could also be used to purchase an additional investment property if serviceability allowed or you could use this equity to fund any shortfall in your new investment loan repayments.
The tax man (through tax rebates) and your tenants (through rent) help pay for the investment loan, however sometimes there is a shortfall that needs to be serviced. This should be taken into account when borrowing to ensure that the loan on the investment property can be serviced within your budget and should include some margin for any unexpected interest rate rises.
Then all you need to do is sit back and let the property take its course with capital gains generating some additional equity over the next seven to ten years, as it has proved to do so (even in tough times) over the last century.
Once you learn this strategy you can repeat it as often as you want, provided you can repay the borrowings.
Buying an investment property through a superannuation fund
Did you know that you can now use your self managed superannuation fund to buy an investment property? You will need to consult your accountant or financial advisor with regards to:
• What you can and cannot do in a self managed super fund (SMSF)
• Benefits of using a SMSF to buy a property
• Challenges and pitfalls
• Using the correct trust structures
• How to correctly source and set up
• How to buy an investment property through a superannuation fund.
As our website contains general advice you might require further consultation to help secure a financial future that suits your unique situation. Please contact our office today to make an appointment time convenient to you. Phone: (03) 9633 7180