INSIGHT

How to use equity to build your property portfolio

If you've wondered how property investors seem to be able to buy property after property without waiting years to save a deposit, here's the secret. They’re probably using their existing equity to fast-track the expansion of their property portfolio.

Equity can be a powerful tool to accelerate your wealth when used responsibly. It is calculated by simply deducting the amount you owe on your property from the property’s value.

For example, if your property is worth $850,000 and your mortgage is $500,000, your equity is $350,000.

As the value of your property rises, so too does your equity, and it can be used as security with your bank if you want to borrow funds to purchase an investment property.

Investors can take advantage of this is by using the equity in their existing home or investment property to fund the purchase of their next property without having to save up a cash deposit. They then repeat the process again when that investment property increases in value, helping them to climb the property ladder faster.

Crunching the numbers

It’s important to note that not all equity is ‘useable,’ as banks typically only lend up to 80% of the value of the property minus the amount you still owe.

So if we use the above example, 80% of $850,000 is $680,000. Then we deduct the mortgage ($680,000 - $500,000), leaving $180,000 of equity, which can be used towards your next property.

Some lenders may lend up to 95% of your equity, if you're willing to pay lender's mortgage insurance (LMI) on the amount you borrow over 80%. LMI protects the bank in the event that you default on your loan, and will be an additional expense to take into account when working out how much equity you have.

Calculating your ‘useable’ equity will also help you to figure out how much to spend on an investment property. Don’t forget to factor in the other costs associated with purchasing a property, including stamp duty and legal fees.

Stay on top of your budget

Even if you’ve benefited from strong capital growth in your existing property, you still need to think about your capacity for repayment before deciding to buy another property.

Banks typically won’t lend on equity alone. They will consider your income, expenses, age, number of dependents and a range of other factors as part of their decision about how much to lend.

You also need to feel confident you’re not stretching your cash flow too far. Could you manage the repayments if the property was untenanted for any period of time? Make sure you have a very clear picture of all the costs – including property management fees, insurance and strata levies – as well as the benefits.

Talk with your accountant to make sure you include any benefits of negative gearing, or the tax implications of your extra rental income.

Maximising your equity

As well as paying down your mortgage sooner or waiting for property prices to rise (again), there are ways to proactively increase your equity.

Location is key – when you’re researching an investment property with capital growth in mind, look for areas with infrastructure projects on the short-term horizon, or potential zoning changes that would allow sub-divisions. This could see values increase faster relative to other areas.

Renovating can also add value sooner – but be strategic and stick to your budget. If your property value goes up by roughly the same amount that you’ve spent on renovations, you won’t be getting ahead.

As the value of your property rises, so too does your equity, and it can be used as security with your bank if you want to borrow funds to purchase an investment property.

The bottom line is for this strategy to work, your property must increase in value. Then, by using your growing equity, you can expand your property portfolio at a faster rate. And the more properties you have, the more equity you can generate, creating a cycle that enables you to accelerate your wealth.

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