Equity is your biggest weapon in building your property empire quickly and safely. We reveal how it works and how to use it to maximise your profits.
Many people overlook the concept of equity when it comes to property finance. Equity is the net realisable value of a property – how much cash you walk away with when you deduct sale costs, outstanding debt and capital gains tax from what the investment is currently worth.
However, there is another definition of equity that is very relevant when you start talking about using equity as financial leverage – that is ‘borrowable equity’. Borrowable equity is essentially the property’s value multiplied by 80% (with 80% representing the amount you can generally borrow without the need for mortgage insurance), minus whatever you owe against the property.
For instance, if the property’s worth $200,000 you can theoreticallyborrow $160,000, but if you owe $100,000 against that property, your borrowable equity will be $60,000 (the extra amount you can borrow using the propertyas security).
Borrowable Equity= property value x 80% – remaining mortgage
Borrowable Equity =$200,000 x80% – $100,000= $60,000
The true beauty of equity is that it increases over time, it is not taxed like any hard-earned savings and it can be used to climb the property ladder much faster than if you attempted to save your hard-earned cash for further deposits on investment purchases.
Deposit power
Most home owners are sitting on a goldmine with substantial equity in their property and they don’t even know it. Equity is like the goose that lays the golden egg in the sense that it can build on itself in a variety of ways and continue to grow and work for you.
One way that equity can increase your potential to make even more equity is by using some of the capital you have in your own home as a deposit for investment purposes. It’s much easier to rely on the escalating capital in your home to generate useable equity rather than trying to save a deposit from scratch for two reasons.
- Equity is not taxed like income (not until you sell it anyway)
- The natural growth a well-placed property attracts will far outweigh any interest rates applicable to a savings account.
In other words, if you are really keen to build an investment portfolio through property, you are far better off adjusting your mindset and getting used to the thought of borrowing more, rather than scrambling to pay off your home.
The key is to buy a good quality asset, let capital growth work its magic over a few years, then re-finance to release the borrowable equity that you can use as a deposit. And there you have it – a simple way to step up the property ladder.
Loving the leverage
When it comes to equity, the more you have, the more agreeable you’ll find lenders will be when it comes to handing over extra borrowings. This is because equity in a property provides them with greater loan security. Using equity in this way is known as ‘leverage’ and it’s an excellent way to gain progress in your property investment endeavours.
Buying property that pays
Whilst this might all sound very promising, there are a number of factors that can bring the entire equity equation unstuck for investors. The most crucial element to being able to access and use equity in property is the actual building of enough capital to generate adequate amounts of the stuff in the first place.
From this perspective, we cannot stress enough how important asset selection is. You need to be investing in the highest quality assets so that you can maximise your chances of enjoying strong capital growth.
Even more importantly, you need to regularly review the performance of the properties you own. You should never settle for second-best so you must dispose of under-performing properties as soon as possible. This is something the vast majority of investors don’t do for many reasons – the primary motive is probably that they don’t want to admit they may have picked the wrong property!
You should be looking for an average capital growth rate of 8% at the very least. Even a 1% reduction in capital growth to 7% will result in a reduction in the value of a property by $316,000 over 20 years. On the other hand, an increase in capital growth by 1%, to 9% will boost the property’s value by $378,000 over the same 20-year timeframe.
That’s why we believe you really should always talk to your broker first. With so much potential wealth on the line, you would be silly not to! Purchasing the wrong asset can be very costly in terms of stamp duty, subsequent selling costs and more importantly, lost capital growth.
From a credit perspective, lenders often give consideration to the location of a property. If people are buying high capital growth properties it means demand outstrips supply and that makes lenders feel confident in the fact that they can realise that asset in a timely manner if required. If the wheels fall off and their client can’t make the repayments, the lender knows that they’ll probably be able to sell the asset quickly and for a reasonable price.
Equity – your biggest asset
Obviously, to initiate these types of strategies, you must have sufficient equity in your existing property and serviceability. Equity is a tremendous asset because it gives you the opportunity to invest without the need to contribute any of your own cash.
Some of you could be sitting on a mountain of equity and not even know it, essentially wasting a great prospect to create tremendous wealth… just because you don’t know how to do it or because you have an innate fear of ‘spending more to make more’.
If you’re really concerned, talk to your broker to get their take on your situation and whether you’re ready to take the plunge…after all you have nothing to lose, but potentially a whole lot of money to gain!
To discuss this article or anything to do with your finances, please contact us today and we will be happy to assist you.
