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  • Profile photo of DanielCumminsDanielCummins
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    @danielcummins
    Join Date: 2006
    Post Count: 37

    Hi all,

    Just a couple of silly questions I thought I’d post, in the hope that someone might be able to enlighten me, and other budding investors. I’m sure there are plenty of people out there who would benefit from hearing these questions answered.

    Having read quite a few investment books now, and growing in knowledge, I still seem to struggle with the whole subject of equity.

    I understand that equity is basically the difference between what you owe on a property, and what it’s worth (basically, the estimated value which you owe), but the details escape me. Once you use equity, does the loan on the principle property get refinanced for the higher amount, or is a simple recording that X amount of equity has been used?

    For example (really simplistic), if I bought a property for $100,000 grand (100 LVR), it would have $0 equity to begin with…
    After 5 years to properties value rises to $150,00 which in theory gives me $50,000 equity.
    If i wanted to borrow against that, what does that imply? What happens? The same with if I wanted to simply redraw that equity into cash…

    If someone could explain in plain english, that would be awesome!

    My second question relates to buying costs. It’s been said manyt imes in these forums that purchase costs normally amount to somewhere around 5% of the purchase price. Where does the stamp duty fit into that? Is it included in that general 5% figure, or should it be factored in separately? It just seems it’s never really included in any profitability analyses I’ve noticed…

    Cheers in advance,
    Dan [biggrin]

    Profile photo of joshadelsajoshadelsa
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    @joshadelsa
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    Good Questions Dan,

    Equity is only ‘equity’ until you draw down on it or borrow against it.
    In your example if your property did go up $50K and you wanted to use that, you could take cash out option which would instantly change the principal value of the initial loan or borrow against it with a LOC (line of credit) which you can draw down on as needed. So each time you draw down on it your equity is effectively decreasing and principal loan value increases. LOCs can be an effective tool as you pay interest on whats drawn down, which is unlike the cash out option where you pay interest on the bulk some you have extracted from the equity.

    When people use 5% for frees and charges it usaully includes Stamp Duty as this is the major cost in most circumstances. It varies from state to state but is usually 4% I think and then approx 1% for misc fees (ie. legal fees, settlement cost etc)

    I hope I’ve explained that right.
    Anyone else got simple ways of explaining this?

    Happy Investing
    Joshua

    Investor Finance
    [email protected]

    Profile photo of DraconisVDraconisV
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    @draconisv
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    I’ve got confusion here aswell.

    Ok same house 100,000(LVR100) and after 5yrs its worth 150,000.
    Loan is still 100,000.
    So say I buy another house for 350,000. And have no deposit and want to use the equity in my other home(150k one).
    I need say a 50,000 deposit. I use my equity.
    Does this mean that my old loan is now 150,000 and my new one 300,000. Or is it still 100,000 and the new one 350,000. This is troubling me as say your loan details are diff(variable/fixed), this is confusing.

    Profile photo of catacata
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    @cata
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    Originally posted by DraconisV:

    I’ve got confusion here aswell.

    Does this mean that my old loan is now 150,000 and my new one 300,000.

    That is my understanding of it, you borrow against your existing equity to use as a deposit on another IP.

    Remember, the only silly question is the one not asked.

    CATA
    Asset Protection Specialist
    [email protected]

    Profile photo of JemnyJemny
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    @jemny
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    HI all,Depending on the type of loan you applied for, .If you went for a 80% lvr the lender would give you 80% of $150000 which is $120000 . cheers john….[medieval]

    Profile photo of TerrywTerryw
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    @terryw
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    Here is an example.

    $100,000 property with $100,000 loan
    LVR = 100%
    Equity = nil

    after 5 years
    $150,000 property, loan $100,000 (interest only)
    LVR = 100,000/150,000 = 66.67%

    You can generally borrow up to 80% of the value without incurring LMI.

    So in this situation you could increase the existing loan to $150,000 x 80% = $120,000. But you already have a $100,000 loan, so that is $20,000 extra you have drawn out.

    You will still have 20% equity in the property after you have drawn this money out.

    You can then use this $20,000 as deposit on another property. eg. $100,000 property, $20,000 deposit, $80,000 loan. You have effectively borrowed 100% of the property value, but now have 20% in this property too.

    wait another 5 years and both properties may be worth $200,000 each.

    Total value = $400,000
    Total loans = $120,000 + $80,000 = $200K
    = 50% LVR

    So you increase both loans to 80% = $320,000 less current loan of $200,000 = $120,000 extra.

    use this to buy 6 more houses.

    Terryw
    Discover Home Loans
    Parramatta
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    Profile photo of Josh-PrestigeloansJosh-Prestigeloans
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    two words :)

    Cross Collateralisation – This can be good and bad, all depends on your situation and what you want to achieve.

    Terryw example doesnt include cross collaterisation, however it is the most perfered method when you want to buy multiple houses, as all loans are securitised by one property rather then many.

    Regards

    Joshua McEwen
    Finance Broker – WA

    http://www.prestigeloans.com.au

    Brokers Lic 1297
    Licensee Brett Christie

    Profile photo of redwingredwing
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    @redwing
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    let make it three

    Serviceability [biggrin]

    I like Terrys example and it spells it out pretty clear for me (thanks Terry)

    “Money is a currency, like electricity and it requires momentum to make it Effective”

    Online Positive Cashflow and Renovating Calculators

    Profile photo of DanielCumminsDanielCummins
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    @danielcummins
    Join Date: 2006
    Post Count: 37

    Cross Collateralisation? Can you explan Josh?

    That makes sense Terry, thanks. I’m just trying to get my head around it though… Because the principle of the initial loan has increased to $120,000 once we draw out the equity, I assume repayments will most probably be higher? You implied I’d need to refinance, is that correct?

    If you wanted to buy that second property, using the first one, it would be the same process of refinancing to access equity?

    I guess I just always imagined drawing on equity to be a rather simple process.

    Profile photo of Josh-PrestigeloansJosh-Prestigeloans
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    Post Count: 62

    **WARNING** This is a long post and i apologise, i hope this answer some questions and it isnt too confusing to understand the jest of what im saying. **WARNING***

    Yes the repayments will be higher as the loan amount has increased. Ring your lender to confirm the minimum repayment amount every month.

    I think what terryw means is doing an internal refinance or what we like to call a “Top-up”. grabbing the equity out of your home by increasing the existing loan amount. Loan amount goes UP your equity goes DOWN.

    If you wanted to use the first property you bought to put a deposit down on the second one, all we do is dip into your equity by toping up your existing loan, so that the equity you diped into can help you pay for a deposit on the house and maybe cover the cost of the fees incurred in buying the property.

    CRASH COURSE IN HOME LOANS TIME!!!

    To obtain equity from your house, you must first apply for a home loan to get it. So for instance, that the house was worth $120,000 now and the loan against the house was $80,000. You effectively have $40,000 worth of equity, but here is where it gets abit strange. All loans have a fee called LMI aka Lenders Mortgage Insurance. Now every borrower doesnt want to pay this because it can be a huge fee dpending on the loan amount. To get around this, we only borrow up to 80% of the value of the house, because if the LVR (loan to value ratio) is less then 80% when applying for a home loan, the LMI (Lenders Mortgage Insurance) is payed by the lender. (if it is a Full Doc Loan)

    So lets put this into an example. You want to buy your first house. Its sale price is $400,000. Most lenders will only allow you to borrow up to 95-98% of the value of the property, thus making you save up the rest, which is alot because you have to cover for all the fees of the lender and the property and also the deposit on the house to make it fit within the banks guidelines. Now you are asking, well what is the estimated fee for Lenders Mortgage Insurance, LMI is calculated on a percentage of the loan amount, this can range from say 0.5% to 3%. We shall use a figure of say 2.5%. 2.5% x $400000 = $10,000 !!!!!! That is only LMI fee, then you got to consider paying the Stamp Duty on the property, application fees, settlement fees etc etc. Its a very hefty chunk out of your savings. To get around this will only borrow up to 80%. Then this figure of $10,000 will go all the way down to 0! However, the money that you have must make up the difference.

    Ok back to the story, you can in fact, dip into this equity whenever you want however it also comes down to the price your willing to pay to get the equity. If you wanted to avoid Lenders Mortgage Insurance, then you will only want to borrow up to 80% of the value of the house. Getting back to the intial example,

    value = $120000
    $120,000x 0.80% = $96,000.

    Take this away from your loan 96000 – 80000 = $16,000. You can easily obtain around $16,000 without paying to much in lenders fees. However, if your willing to pay for the LMI then you can borrow up to 95%.

    $120,000 x 95% = $114,000.
    $114,000 – 80,000 = $34,000

    $34,000 is what you can borrow up to (depending on Income of course), from this you gotta deduct LMI, application fee, mortgage stamp duty etc etc.

    So it all comes down to what your willing to pay to grab the most amount of equity.

    END OF CRASH COURSE :)

    Now! Onto Cross Collaterisation. Its quite simple, its using your equity on your current property to help cover the cost of purchasing the next property, but your not increasing your current loan, your multiplying the securities on the new loan, thus have a 2nd Mortgage over your current Property. Let me explain, Cross Collertisation means your placing 2 or more securitys on ONE Loan. An example will help understand this better.

    2 Propertys:

    Property A = $120,000
    Property B = $150,000

    Total Loans against Property A = $50,000
    Property B is the house your buying.

    You go to CBA and apply for a loan of $157,500 to buy Property B plus a little bit extra to cover the fees incurred……..wait Josh, didnt you say that Lenders will only lend you to a percentage of the property value…… Well yes that is correct.

    The LVR in this example is

    $157,500 / $150,000 = 105%..But Josh…didnt you say most lenders will only lend to about 95-98% of the property value…well yes……So how do we get this LVR, currently at 105%, to 95-98%….well it lies in the equity existing in the current property. When you apply for the loan, when you say which property will be securing this loan, instead of the loan securing one property, its securing two propertys…..does this become abit clearer??…….sooooo we use this simple The cross collateralise equation:

    Total Loans / Total Value = LVR
    ($50,000 + $157,500) / ($120,000 + $150,000) = your LVR is now 76% rather then 105%, making the transaction alot more affordable.

    So basically, cross collateralising is securing many propertys against one loan. However this isnt always advisable, as it becomes abit “messy”. As its hard sometimes to remember which property is securing which loan and if you want to “discharge” one of the securities off the loan. Most buyers/investors would like a very tidy loan, One Security Over One Loan.

    Like i said, i apologise, i hope i havent confused the hell out of you’se.

    Regards

    Joshua McEwen
    Finance Broker – WA

    http://www.prestigeloans.com.au

    Brokers Lic 1297
    Licensee Brett Christie

    Profile photo of DanielCumminsDanielCummins
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    @danielcummins
    Join Date: 2006
    Post Count: 37

    Josh, the last thing you need to do is apoligise… Thanks so much for writing such a long and helpfull post!

    The question I was leading to was how much MPI cost, but you also covered that! I guess it comes down to working out weather it’s better to pay the MPI and have the advantage of taking out a higher LVR loan, or saving a larger deposit and keep LVR at 80%, right?

    Profile photo of Josh-PrestigeloansJosh-Prestigeloans
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    Post Count: 62

    hit the nail on the head!

    Anyway is possible, its up to you to choose the path you want to go down.

    MPI = Mortgage Protection Insurance is different to

    LMI = Lenders Mortgage Insurance

    MPI is protecting your repayments if you fall ill or lose your job or become disabled. This is an insurance that you take out for piece of mind so that any time in the future that you may not be able to make repayments on the loan, then the MPI company will pay them for you untill you reach to your normal status again

    LMI is protecting the lender from any misconduct you make on the loan, so if you fall down the crapper and the house is sold under the mortgageee, however the proceeds of the house doesnt fully cover the loan + Solicitor fees + Enforcement Fees yada yada yada, then the LMI company pays the gap to the lender. LMI is protecting the lender not you.

    Regards

    Joshua McEwen
    Finance Broker – WA

    http://www.prestigeloans.com.au

    Brokers Lic 1297
    Licensee Brett Christie

    Profile photo of v8ghiav8ghia
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    Join Date: 2005
    Post Count: 871

    Hey Josh….great explanation, especially re the cross collatoralizing. Pro’s and con’s both ways that’s for sure. Thanks[whistle]

    Profile photo of DraconisVDraconisV
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    Remember, the only silly question is the one not asked.

    Thats my attitude to anything. If I don’t know I ask, its the only way.

    Thanks Josh that deserves a round of applause. Great stuff. So much more understanding has now come to me, thank you.

    Christopher.

    Profile photo of Simon CSimon C
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    @simon-c
    Join Date: 2004
    Post Count: 52

    Hi Daniel

    Just to add to Josh-Prestigeloans sensation post, and in particular cross-collateralisation, it can get trick, and also restrictive, or less flexible.

    If you have one or more properties securing others, and for some reason you may need to sell a property securing another property, if your valuations do not stack up you could find yourself having to come up with some cash to prop up the LVR or may need to take out LMI should your LVR exceed 80%

    Depending on where you invest LMI may not be an issue, other than an unwanted expense. In some region areas LVR’s can be less then the usual 80% and in some cases mortgage insurers do not offer LMI for loan (quite a few mining towns and small regionals as I discovered about 18 months ago, not sure if this is the case, but ask it you are looking to invest in those areas)

    I recently went through an exercise of undoing C-C and fortunately all it cost me was time, but some instituation will charge you for valuations and new loan structuring fees etc.

    I have basically taken an LoC against my PPOR up to 80% LVR and use this as my deposits and costs engine, then borrow up to the LVR permitted on the property I am buying to avoid the need for LMI.

    Now when I decide to offload a property I do not have to worry about cross-collateralisation being an issue for me as it was or could have been.

    Its different for everyone, but if you consider that method, get plenty of advise from some experts.

    Cheers
    Simon C

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