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So you own your own home, have paid off a large chunk of the mortgage and are thinking of investing in another property or holiday home? For many investors, the first step in building a property portfolio involves using the equity they have built up in their family home to ‘leverage’ other investments.
Equity is simply the difference between the value of your property and what you owe on it. For instance, if your home is worth $150,000 and you have a $50,000 mortgage, you have $100,000 equity. Depending on your individual circumstances, you may be able to borrow (leverage) against this equity to invest in another property, buy shares, renovate, purchase a new car or take a holiday.
Lisa Dudson, Vice President of the New Zealand Property Investors’ Federation and head of Acumen Financial Planning, says more and more New Zealand property investors are using equity to help build their property portfolio.
“Typically a lender will look at your whole balance sheet, whether it is held personally or in a trust. So if you own a $100,000 home with a $50,000 mortgage, you can use a proportion of that equity as a deposit on a new property. The lender will look at what property you currently have and the total value of your property holdings to ensure it fits into their ratios.
“When using equity as a deposit on an investment property, the same 80/20 borrowing rule applies. Some lenders will even allow you to borrow up to 95% of the value of the property using Lenders’ Mortgage Insurance,” she explains.
Say, for example, your home is valued at $200,000 and you owe $100,000, leaving $100,000 equity. If you then purchase a $200,000 investment property, your total borrowings increase to $300,000 against total property valued at $400,000, giving you a ratio of borrowing to equity of 75/25.
Ms Dudson said equity investing offers many advantages.
“When buying an investment property the larger the deposit the lower the return on your actual investment. This is because the return is based on the amount of money you invest. If you are 100% financing using equity from your home, you are effectively putting in zero so your return is based on zero inputs.”
Ms Dudson says using equity in the family home to purchase an investment property can short-cut the often lengthy process of saving for a deposit.
“This way you can enter the investment property market at a much earlier stage because rather than saving for a deposit, you are using the equity in your home as the deposit
“A key reason for investing (in residential property) is if you can borrow 100% of the purchase price and buy a property that is self funding,” Ms Dudson says.
Moreover, surging property values mean many home owners have considerably more equity in their properties than three or four years ago. Unlocking that value is a key advantage of equity borrowing. Of course, all debt must be carefully managed to maximise the investment returns and minimise the risks. Investors should also remember that property markets are cyclical and that the current pace of house price growth is unlikely to continue indefinitely.
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