Build a secure financial future by using the equity in your home for your investment property (IP). This is the key to building wealth through property.
Okay, you’ve lived in your home for a few years and have been diligently been paying down your home loan… you may be wondering what your home is now worth, and I’m sure you’ve heard those “savvy” in-laws talk about all their “equity” last Christmas dinner… you sat there, nodding, but didn’t really have a clue really what they meant. So let me tell you!
An Investment Property (IP) loan is a type of home loan that you would take out to buy an investment property. It is a mortgage solution for those who want to buy a property and rent it out to receive income, but don’t have a lazy few hundred thou’ in the bank to pay cash for the property, so they would need to apply for an IP loan.
So what were your in-laws talking about when they mentioned all of the “equity” they have? Let me give you an example. Your home is worth $500,000 and you still owe $310,000, your equity is $190,000. Sounds straightforward enough but in reality it’s not quite that simple when it comes to accessing that equity through your lender. The lender will send a valuer to your property (sometimes at your expense), and the figure they come up with may not match up to what you think its actual market value is.
Even if your property does value well, banks won’t lend you the full amount anyway because if house prices drop, they don’t want to have an outstanding loan that’s worth more than your property. Generally, banks will lend you 90% of the value of your home, less the debt you still owe against it. This is your “usable equity”. It’s important to note that borrowing over 80% will mean you have to take out Lenders Mortgage Insurance (LMI*) so you will need to add this into the purchasing costs of buying the new IP.
*LMI is a once off cost that is normally “capitalised” (added on top of) your IP loan. It is important to note that LMI protects the bank, not you, as the more you borrow (higher LVR**) means the risk to the bank gets higher. LMI kicks in over 80% LVR.
**LVR stands for Loan-to-Value-Ratio. Visualise this, you have a $100,000 value property (yeah yeah I know, that’s practically impossible these days, but we need to use simple numbers so you can easily pick up what I’m putting down)… So, you have a $100,000 (valued) property with an $80,000 home loan borrowed against it. This is an 80% LVR as you have borrowed 80% of the properties value.
The good news is that your property’s equity will increase both as you 1. pay off your mortgage and 2. the property’s value increases. So, going back to the example above, if your $500,000 home increases in value by 10% over 12 months that’s an extra $50,000 in equity. Also, lets assume you have paid the $310,000 home loan down to $300,000, you have effectively built an extra $60,000 of equity into the property over that year.
IP loan vs Home Loan – what’s the diff? IP loans differ to standard home loans as they have stricter eligibility requirements. One restriction when borrowing for an IP is that your LVR requirements will be higher, meaning you will need a larger deposit compared to buying an owner occupied home. IP loans typically also come with higher interest rates than residential (owner occupied) home loans.
- Interest on the investment loan
- Home and contents insurance and landlord insurance
- Real estate agent’s commission
- Your conveyancing solicitor fees (both in buying and selling the property)
- Maintenance costs
- Council rates
- Decline in value of depreciating assets
- Construction costs (“capital works”)
- Travel expenses to the property to do an inspection, maintenance or repairs
Obligatory Disclaimer: At MTM we are not licenced tax agents, so it is important to speak with your accountant on the above points before you make any life-altering decisions!