- SonyaParticipant@bonzasonzaJoin Date: 2014Post Count: 6
Hello everyone, I am new to these forums and quite new to property investing, and I’m hoping to better understand the principles of equity.
I am 30, currently on maternity leave until mid next year (new baby), and my husband and I have recently received a financial windfall. My husband was made redundant (two days before the delivery!) and we have inherited some cash. We are looking to use this opportunity to get further into property investment. I will return to work and husband will be primary carer plus he’s currently earning some $$ each month doing short term contract work (charges hourly for high-level IT engineering/sys admin so can get by with a few hours here and there)
I do not fully understand equity however, and I am hoping you all might be able to help with general information.
My husband and I have two properties: house worth $520k with $390k mortgage, and unit worth $425k with $312k mortgage. The unit is tenanted at $330 per week (slightly under market but an excellent tenant for 4 years now) and the house (our current PPoR) is worth $510-$540 per week. We are moving in with family and putting up the ppor as a rental. The interest paid each month on both loans combined is $3000 per month, and though we are paying principal +interest presently if we switch to interest only i think they will be neutral/positively geared after fees and expenses.
We have total $80k cash as a combination of the severence pay, inheritance, and money in the offset account.
I understand that equity is the difference between the value of the house and the debt owing, and that you can use equity for a deposit on another house, but I don’t understand how. Assuming we can only use 80% of our equity to purchase another house that is still $150(?)k towards another house, plus the $80 cash we have, we should be able to buy another property even with the drop to one income.
How do you tap into that equity? Does the existing loan get refinanced and existing mortgage repayments increased? Does the lender simply use the equity as collateral against a loan on the new property for the full purchase price but existing loan payments are unchanged and new repayments are based on 100% purchase price? Does using the equity to fund the next purchase affect us at tax time if the equity in a previous PPOR (now rental) is used to purchase the next PPOR? I don’t really understand all the implications.
We are taking the opportunity to go interstate for an extended visit with family and hope while there to buy either a positively geared rental or modest home for ourselves <$350k. We have already been pre-approved for a $250k mortgage based on solely my wage subject to my return to work, and we know we can afford it, but the longer I can delay that return to work the better :)
You’re pretty much correct in your understanding of equity and how to access it. The most common way is to access it via a Line Of Credit (LOC) which is a separate loan. Using your PPoR as an example if you draw on equity up to 80% of the loan value (you could do higher but you would be entering LMI territory) you would have a LOC of $26k which would be secured against your PPoR but as a separate loan and you would draw upon as needed.
One of the methods you mentioned as well was cross collateralisation which is where the bank accesses equity in your existing property to go towards the purchase of the new property but not via a LOC. You would have two titles secured against the one mortgage which can get messy and is advisable to avoid in most situations.
Hope this helps.
Also, forgot to add – you should turn your loans to IO – do you currently have an offset account against your PPoR that the $80k is sitting in? As much as possible you should use OPM (other people’s money ie the banks) to fund investment purchases for a few reasons, one including maximising your tax deductibility.SonyaParticipant@bonzasonzaJoin Date: 2014Post Count: 6
Thanks for your response Kinetic.
I feel a bit silly, but there’s still something fundamental that I’m missing in the concept of using equity to purchase a home. In using equity in lieu of a cash deposit you are in essence still using your own money for a deposit on a house, you’re just “borrowing” from the increased value in your current home to do so.
If that’s the case, how is it possible to amass a portfolio of properties given that borrowing capacity is still limited by the income you earn – which is a finite resource. If I’ve borrowed to my maximum borrowing capacity, then build equity through time or renovations, how can I use that increased equity to purchase another if my income has not increased? I still need to be able to service the debt. My medium term goal over the next 5-7 years is to have a passive income stream that is enough to cover all the mortgages including my PPOR, and to enable me to work because I want to, not because I’m dependent on the next paycheck coming in. My long term goal is to be able to retire at 55 and live off the rental income.
Thinking logically, I would guess that finding positively geared properties would help with cash flow and affordability, but they’re not easy to find and that’s not the best way to get good long term wealth. From all the reading I have done the best way to do so is to find a property with good capital gain prospects in a major city, but these are almost always negatively geared, or to find undervalued properties and renovate for profit. Given the large transaction costs associated with property (and my complete inexperience in any tradie work) I am not at present interested in flipping properties. I would like the warren buffet approach: to never sell (unless presented with an offer too good to pass up, but I’m not counting on that happening).
I guess the bit that I don’t understand is how to build a portfolio of properties without increasing your income or selling up to realise some cash profit.
No worries – don’t feel silly!
You’re correct in what you say about how the equity works – you are increasing your debt.
The trick is to find the right balance – as you purchase new properties you will be renting them out – that rent is then income which in turn increases your serviceability but you want the capital growth too. As you’ve probably discovered easy to say, a little trickier to do. You just need to make sure you buy right – near the bottom of a rising market and hold. If you’re not confident with flipping then maybe look into developing so the small stuff like granny flats or sub dividing and grow from there. You could also get creative with student accom/boarding house, holiday letting for cash flow but each has their own challenges.
You will hit your serviceability limits eventually but hopefully that will be at or close to the stage where you just want capital growth and rental increases to take care of your portfolio. That’s when you play the waiting game.BennyModerator@bennyJoin Date: 2002Post Count: 1,416
Welcome aboard !! It is good to hear that you are looking for options – this means you have your future firmly in view. I think a good move for you is to keep on reading, checking, questioning, and working toward that future. A chat with one of the Mortgage Brokers would be useful too – they can take your whole financial situation into play when working out HOW to buy another property.
For now, I just wanted to point out a common trap. And that is in thinking you have “80% of your equity available” !! It is not quite right, so let me set that right :-
You said :-
Assuming we can only use 80% of our equity to purchase another house that is still $150(?)k towards another house, plus the $80 cash we have, we should be able to buy another property even with the drop to one income.
The way to calculate what you can borrow is as follows:-
First, look at the “amount owing / house value”.
In the case of your PPOR, owing is $390k / value is $520k that is 75%. But you CAN’T borrow 80% of that remaining $130k (your Equity). Just $16k more will bring your total loan to $416k which is 80%.
You could draw a bigger chunk of Equity by considering paying LMI and borrow at 90% (or 95%) instead of 80%. That would release another $78k (or $104k) for you.
With the Unit, things look a bit better – Owing $312 / Value $425 is around 73.5% LVR right now. By going to 80%, this releases $28k – or pay LMI and borrow at 90% (or 95%) to release $70k (or ~$90k). And HERE is where you need the services of a professional to run different scenarios for you in your circumstances.
WHAT you buy will play a part too – do you purchase another IP? Or another PPOR? Your answer will have a major impact on the outcome – or, the Mortgage Broker can chart BOTH scenarios, thus allowing you to make an informed choice.
Main thing is though, I hope you can now see that you can’t borrow “80% of your Equity” as easily as it sounds. You have about $240k in Equity, but to borrow 80% of that ($192k), you need to borrow it at an LVR of 95% plus !!!!
And don’t be concerned if it is all still not clear. Once you sit down and “do the numbers” with an adviser, it will become a lot clearer.
You are in good shape though, and I’m sure something can be done to improve your future with property. Let’s see what a MB tells you,
- This reply was modified 5 years, 7 months ago by Benny. Reason: Fixing an earlier transcription error