What a lot of Australians don’t realise is that they could potentially already be sitting on a deposit for an investment property if they’re already homeowners.
What we’re going to unpack is exactly how investors are pulling equity out of their owner occupied house and then purchasing investment properties with zero cash deposit. A lot of people have a pretty substantial amount of equity in their house that they don’t realise, so we’ll break down the step-by-step process of how to do it.
A lot of homeowners just assume they don’t have the capacity to go and buy another house, but a lot of people have a pretty substantial amount of equity in their house already.
Understanding equity with a real example
So, we’ll get straight into it. In this example, it’s a million-dollar house with a $600,000 existing home loan.
The first thing I want to explain is equity is the amount against the house that you own without any sort of loan secured against it. So, in this case, a million-dollar house with a $600,000 home loan, there’s $400,000 worth of equity there, but we can’t use all of that.
Most lenders will only allow you to go up to 80% of the value of the house without paying lenders mortgage insurance. So that leaves us $200,000 that we can use.
Now, in some cases, if you want to go up to 90%, you just pay the lender’s mortgage insurance. There’s not many lenders that will allow you to refinance up to 95%, but a lot will allow you up to 90%.
And you’re making back that lender’s mortgage insurance pretty quick in capital growth. In that case, can you potentially capitalise that LMI as well if you say you’re borrowing up to 88% and then using that extra 2% as lenders mortgage insurance to let you go up to 90%. Essentially in this case we’ve got $200,000 worth of equity.
Why leaving equity unused is often a missed opportunity
Now, letting that sit there, in a lot of cases, it’s not a great idea. This isn’t a strategy for people to buy 50 or 60 properties, but most investors, as we talked about in previous episodes, are mum and dad investors with one property.
You can just rely on your owner occupied property to continue to compound and then that’s your retirement nest egg, but typically what you’re doing is selling to realise some sort of gain and to support you through your retirement. But then you’re buying within the same market, so you almost don’t have that money to put in your pocket.
A lot of homeowners just have their owner occupied property. They’ve got equity sitting in there that they can tap into to get one investment so that when they do sell, they can sell sideways for their owner occupied property and they’ve got their investment to rely on.
One thing that people need to realise too, is that cashing out equity does increase your loan. It’s not just free cash or free money. I’ve had people previously say, “Oh, can I release my equity to pay out my home loan?” No, that’s a misconception.
Essentially, you’ve got two ways you can release equity: sell the house or secure a dollar for dollar against that equity, and the lender will then give you the money in exchange for a mortgage over that portion of the security.
Step one: Finding your property value and loan balance
So, we’ll go through the steps now. The first step is you need to get a realistic property value for your house. The best way to do that is to contact a mortgage broker to get a valuation. We can do free valuations.
From a high level, for a homeowner who’s just thinking, “I wonder if I have equity,” the best thing to do is to punch your address into Google and look at PropTrack data on realestate.com.au or Domain. It’s not 100% accurate, but it will give you a rough idea.
Next is your loan balance. Log into your internet banking and get your loan balance. Then we can start to work out how much equity you’ve actually got and work backwards from there.
Step two: The best way to access your equity
The second step is to decide how we’re going to access that equity. The best way to do it, especially for tax reasons, is to create a second split.
So let’s say you had that $600,000 loan. We don’t want to just increase that single loan by $200,000 and make it $800,000 because when it comes to tax time, it can get difficult.
Instead, you create a separate split. This could be interest-only or principal and interest. Talk to your accountant. Choose what suits you best. Most people would go interest-only because it’s tax deductible and have that as a separate split.
You can either cash that out and have it sitting in an account ready to go, or just have a formal approval or pre-approval ready for when you need it.
For people who aren’t completely across this process, talking about splits, drawing equity out, and speaking to your accountant might sound complex, but essentially your mortgage broker, buyer’s agent and accountant guide you through it. If you structure these things correctly at the start, life’s a lot easier at the end.
A less common way people do this is by creating a line of credit against their house. Not many lenders like lines of credit anymore because it’s like a huge credit card. You only pay interest, and if people aren’t disciplined, they can end up using it for holidays or cars they don’t need.
Doing it in a way where it’s directly linked to the purchase is often easier and smarter.
Step three: Using equity to fund an investment purchase
In this case, step three, we’ve figured out we’ve got $200,000. If we purchase a $750,000 property, a 20% deposit is $150,000. Then you’ve got around $35,000 in stamp duty and conveyancing costs depending on the state, taking us to about $185,000.
I’d still recommend using the full $200,000 because you want buffers in place. Rates go up, vacancies happen, hot water systems break. Put the remaining amount into an offset account set up specifically for that property.
I’d also recommend having a separate transactional account just for that property. Rent goes in, repayments come out, and if there’s a shortfall you top it up. It’s easy to manage and easy to track.
Step four and five: Loan structure and settlement
Step four is getting your pre-approval and finding a property. You don’t have to buy at $750,000, that’s just an example. You can buy around $500,000 as well, depending on your equity and servicing.
Just because you have the equity doesn’t mean you can pull all of it out. You still need to service the debt. That’s why it’s important to sit down with someone who understands this and looks at the long-term strategy.
Step five, once you’ve found the property, you’ll end up with a few splits:
- Split one: the original $600,000 home loan
- Split two: the $200,000 equity release
- Split three: the loan secured against the investment property
That’s it.
Common mistakes to avoid when releasing equity
In summary, it’s not overly complex. Find out the value of your property, work out how much loan is owing, use up to 80% of the value, and calculate your usable equity. Then work out your servicing, find the right property, and structure it correctly.
Buying in the right location at the right time can make a massive difference. A slightly higher growth rate over 10 years can mean hundreds of thousands of dollars more in value. Buyer’s agent fees can be built into the equity and are tax deductible.
Some common mistakes people make include cross-collateralisation, where banks bundle multiple properties together. This can cause problems when selling and isn’t recommended.
Another mistake is overestimating rental income to get a higher pre-approval. Always be conservative and leave buffers.
Finally, get your property leased prior to settlement where possible, get insurance in place, and be proactive.