Whether you're looking to buy your dream holiday house or an investment property, equity can be a useful asset to help secure your second home. This is a popular investment strategy as many investors access equity on their home loans to improve their financial situation and purchase a property with no cash deposit.
In this blog post, we will help you understand what equity is, how to access it and how to leverage it to ensure the success of your property investment.
What is Home Equity?
Home equity is the market value of your existing property, minus your outstanding loan balance.
In theory, the longer you've owned your property, the more equity you will have in it. This is due to your regular loan repayments that reduce your outstanding debt, alongside the increasing market value over time.
For example, if your current property value is $800,000 and your debt is $300,000, you would have $500,000 of equity in your home.
Why Use Equity?
As your home equity is viewed as an asset by financial institutions and mortgage brokers, it can be utilised in various ways when purchasing a second property. This can include organising an investment loan around your equity or buying a property with no deposit.
Furthermore, you can also save money on lenders mortgage insurance (LMI) if your equity deposit is more than 20% of the property value.
How Much Equity Can Be Used?
Generally, banks will lend up to 80% of your property's market value. When the 80% is deducted from the amount owing on the property, the remaining money constitutes the accessible equity.
Consequently, the amount of equity available will vary from property to property as it depends on their independent factors.
How Do I Access Equity in My Home?
If you want to buy a second home with your usable equity, you will need to refinance your property. Refinancing your mortgage involves moving your home loan to a new lender or changing your particular loan product. When you refinance your mortgage, it releases your available equity for your personal use.
You must undergo a property valuation to have the latest information on your loan to value ratio (LVR) when refinancing. This will ultimately determine the total usable equity that you can access.
While this is a popular option for unlocking equity for people looking to buy an investment property, it carries some risk. We recommend consulting a financial adviser, as they can assess your finances and provide independent advice relevant to your own circumstances.
Using Equity to Buy a Second House
Using equity to buy a second home can be a confusing process that often discourages people from expanding their property portfolio.
If you're looking to enter the property market using your available equity, read our following 6 step guide. We will walk you through each phase of using equity to buy a second house.
1. Calculate Available Equity
Your first point of action in acquiring a second home will be to calculate your available equity. The available equity is calculated using a figure of the estimated market value of your first property. This figure is often based on comparing other properties on the market in your area, or a valuation undertaken by real estate agents.
Once this figure has been determined, it will be deducted from the balance of your current loans for your first property.
2. Calculate Accessible Equity
Once your available equity has been determined, you will need to confirm your accessible equity.
Lenders can limit the amount of equity you can access if they think it will hinder your ability to repay extra loan amounts. Commonly, lenders decide this based on an analysis of your expenses, employment, debts and source of income.
For example, James figures out that he has $200,000 of available equity in his home and wants to buy a second property. However, based on his financial portfolio, James can realistically only meet $100,000 in extra loan repayments. Therefore, lenders would determine this $100,000 to be his accessible equity.
3. Look at Loan Options
After determining the value of your accessible equity, you will need to crawl through the market for the best loan options. This is a good chance for you to assess your current interest rate, loan structure, fees and features (such as an offset account or redraw facility) against other lenders. It's important to keep in mind that lenders may charge an additional fee if you want to access your equity, so you'll have to be meticulous in your research.
A helpful tool to help you here is using Joust Live Auction. Instead of endlessly trawling through the market for the best options, Joust provides the best loan rates to your doorstep by placing your mortgage on a competitive marketplace for lenders to bid on.
Once you have found your ideal option, you'll need to assess personal circumstances to ensure approval of your loan application.
4. Assess Costs for Accessing Equity
An important consideration is that lenders may charge an additional fee for refinancing your home loan to access equity. This is especially true if you choose to switch lenders.
Another thing to keep in mind is that if you access more than 80% of your home's value, you will be facing additional costs with mortgage insurance.
Therefore, it's a good idea to organise your finances and ensure that you can cover any additional fees or costs that may incur due to accessing equity. Obtaining financial advice from a third party is always a good idea to ensure you can successfully access your equity.
5. Loan Application
After you have consulted with your financial advisor and considered all loan options, you can progress to your loan application. Although you may have an excessive amount of equity, lenders still can reject your application to borrow against it.
For a lender to approve your home loan equity application, you will need to fulfil the following criteria:
- Pay 20% off the current value of your property: This will require you to add your deposit with the total amount of your repayments. The final amount will need to be higher than 20% of your current property value.
- No missed repayments: This will help boost your borrowing power and make you more attractive to other lenders. Banks tend to reject applications on people who have missed one or more repayments on their home loans.
- Indicate a steady stream of income: When accessing home equity, you will need to provide your last two payslips. People employed on a part-time or full-time basis are more likely to have easier access to home loans because of their consistent streams of income. If you have casual employment you would need to have an established credit history with positive reporting.
- Sound loan portfolio: A loan portfolio is a pool of loans that act as assets, whether it is mortgages, commercial loans, home equity, and other credits. Loan portfolios, when properly managed, can assist in home loan applications because they further demonstrate your ability to manage your finances. If your loan portfolio is too large or has defaults, this would be disadvantageous in any application, not just one for a home equity loan.
Following your application, you can expect a settlement on your loan within six weeks after the exchange of contracts. However outside factors could impact the timing of approval and settlement.
How to Increase Home Equity in Property
If you're looking to buy a second property in the future, there are ways to invest in your current home to boost your equity. This includes home improvement, injecting cash, additional payments into your offset account, reducing debt and making extra repayments.
Renovations and other home improvements can be a good way to increase the potential value of your home. When the value of your home increases, generally speaking the equity available will increase too.
Home improvement almost always increases the value of properties, unless there are unprecedented events impacting the current market value of properties in the area.
Home improvements to consider includes:
- Building a granny flat, subject to approval
- Updating your kitchen, bathroom, laundry
- Modernising the design
- Undertaking eco-friendly additions (e.g. solar panels, water tanks)
- Adding more car space (e.g. garage renovation or carport installation)
- Refurbishing living spaces and bedrooms
- Landscaping and boutique gardening
The cost to improve your home must be weighed against the potential increased value. You would not want to max out on renovation costs and have little profitable returns for valuation come the completion of the project.
Consult with your real estate agent to determine what home improvements could be undertaken to improve property value.
Injecting Cash into Loan Repayments
This may seem like a no-brainer, but if you already have available cash reserves sitting in your savings account or other investments, you should consider whether you can afford to inject some extra cash into your loan.
Making extra repayments on your home loan will not only help pay off your mortgage faster, but also increase the total equity available.
Offset Account Savings
An offset account is a common loan feature that acts as a savings account that's connected to your home loan. Essentially, when an offset account is used, you can pay off your current home loan faster, therefore you will have more available equity from your property.
On top of that, the money you saved on interest can be used as injectable cash for boosting the equity.
Final Considerations When Using Equity to Buy a Second home
Before you decide it’s time to buy a second home using equity, there are some important considerations you need to factor in first.
Do you have the financial stability to pay off two mortgages simultaneously?
Consult with your financial adviser to prepare a fiscal plan so you can achieve your investment goals.
There are other overlooked costs with purchasing another property, including:
- Stamp duty
- Property title transfer fee
- Registration fee
- Conveyancing fees
- Inspection fees
Oftentimes, people choose to refinance their mortgage to get a better interest rate on their current property - and in turn have more equity to buy a second property.
You will need to consider the options available and whether it will cost or save you money switching from your credit provider to a new one.
Can I Use Equity in My House as a Deposit?
Yes, equity can be used as a deposit for a second property, such as an investment property or holiday home. The existing home can then act as security for the new home equity loan.
How Does Accessing Equity Affect My Loan Repayments?
Put simply, if you increase your home loan - including by having a second mortgage for an investment property - then your loan repayments will increase.
The interest rates might change, but the timeline of your first repayment should not change.
Is Home Equity Loan a Second Mortgage?
In a sense, yes, a home equity loan is a second mortgage. A home equity loan can be used towards a second mortgage acting as a security asset for the new property.