Us­ing home eq­uity for in­vest­ment

Monthly Chronicle - - Front Page - RAJ LADHER Raj Ladher is a lo­cal ex­pert on mort­gages and fi­nan­cial mat­ters. Orig­i­nally from the UK, his con­sul­tancy firm is now based in Syd­ney.

It’s a word a lot of my prop­erty in­vestor clients know about. Lever­ag­ing is where you utilise your cur­rent as­sets to in­crease your in­vest­ment port­fo­lio. The as­set in prop­erty in­vest­ing is usu­ally a prop­erty that you own – this could be your prin­ci­pal place of res­i­dence or an in­vest­ment. There are two re­quire­ments for lever­ag­ing.

Firstly you need eq­uity - a prop­erty where you have either paid down a por­tion, and/or it has in­creased in value. Se­condly, you need the bor­row­ing ca­pac­ity to bor­row ad­di­tional funds from a bank.

Step one: Ac­cess­ing your eq­uity

For ex­am­ple, you bought a home for $500,000 with a home loan of $400,000, giv­ing you a Loan to Value Ra­tio (LVR) of 80%. A few years later the prop­erty in­creases in value and is now worth $700,000. For sim­plic­ity, the home loan is still worth $400,000 giv­ing you a LVR of 57%. To avoid lender’s mort­gage in­sur­ance you can in­crease your loan back to 80% LVR = $560,000, giv­ing you $160,000 in funds to pur­chase an in­vest­ment prop­erty.

Sum: Prop­erty value= $700,000/80% LVR = $560,000 mi­nus $400,000 cur­rent debt = $160,000 raised eq­uity

Step two: Fur­ther bor­row­ing

Now you have your funds for a de­posit and le­gal costs, you can start work­ing on look­ing for an in­vest­ment pur­chase. You find an in­vest­ment prop­erty for $500,000 which re­quires you to put down $100,000 as a de­posit (20% - again waiv­ing the re­quire­ment of lender’s mort­gage in­sur­ance) and $30,000 le­gal costs, i.e. stamp duty, etc = $130,000. You now need a loan from the bank for the re­main­der of the $400,000.

Sum: Pur­chase price = $500,000 mi­nus $100,000 de­posit = 80% LVR - $400,000 in­vest­ment loan re­quired.

You’ll need to demon­strate af­ford­abil­ity to the bank for both of the steps above. Most banks will also re­quire you to ex­plain what the ini­tial eq­uity rais­ing is for - fur­ther in­vest­ment pur­chase.

You now have a prop­erty port­fo­lio worth $1,200,000 ($700,000 ex­ist­ing home + $500,000 new in­vest­ment pur­chase) which is grow­ing over time, with a debt of $960,000 ($560,000 + $400,000) = 80% LVR, which is re­duc­ing over time. This in­cludes a $30,000 buf­fer re­main­ing from the eq­uity raised.

The above steps are one way of lever­ag­ing. You can also cross-col­lat­er­alise your prop­er­ties which means the prop­er­ties are se­cured against each other. Some in­vestors and fi­nance pro­fes­sion­als pre­fer this method as the set-up of the fi­nance is sim­ple, while oth­ers pre­fer an ap­proach where the prop­er­ties are in­de­pen­dent of each other with dif­fer­ent lenders.

Ben­e­fits of lever­ag­ing

It al­lows you to start/in­crease your in­vest­ment port­fo­lio with­out hav­ing to use your hard earned cash. Sav­ing $160,000 can take a long time and could mean that you have to wait longer to buy the in­vest­ment, in which time you could po­ten­tially lose out on fur­ther eq­uity with in­creased prop­erty values.

Hav­ing spo­ken to your ac­coun­tant, you may find that rais­ing eq­uity on your prop­erty could work out to be more tax ef­fec­tive than putting in your cash/sav­ings. Al­though you’re bor­row­ing more money and putting you in fur­ther debt, the thing to re­mem­ber is that this is ‘good debt’.

Lever­ag­ing doesn’t nec­es­sar­ily mean that you need to buy an in­vest­ment prop­erty. You may be a par­ent who would like to help your chil­dren to get on the prop­erty lad­der and lever­age your prop­erty as a se­cu­rity. This could save them sig­nif­i­cant time of hav­ing to wait years to save for a de­posit along with miss­ing out on po­ten­tial eq­uity. Once your chil­dren’s prop­erty is at a LVR of 80%, your prop­erty can then be re­leased – this is called Parental or Se­cu­rity Guar­an­tee.

Dis­ad­van­tages of lever­ag­ing

Lever­ag­ing can prove to be de­struc­tive if mea­sures aren’t put into place. For ex­am­ple, what hap­pens if you don’t find a ten­ant for your in­vest­ment pur­chase, have you got means of pay­ing the mort­gage if you lose your job, what hap­pens if in­ter­est rates sky­rocket? Lever­ag­ing does put your ini­tial prop­erty at risk in ad­di­tion to your new pur­chase should things not work out, which po­ten­tially in­cludes the roof over your head.

The Aus­tralian Pru­den­tial Reg­u­la­tion Au­thor­ity (APRA) has re­cently curbed in­vestor bor­row­ing due to the amount of debt bor­row­ers have lever­aged, more no­tably in Syd­ney and Mel­bourne.

A num­ber of stress tests need to be put in place along with cash re­serves, i.e the $30,000 ad­di­tional in­come raised from the eq­uity to cover mort­gage pay­ments and un­ex­pected costs.

Lever­ag­ing and in­vest­ing in prop­erty re­quires pro­fes­sional ad­vice from mort­gage pro­fes­sion­als, ac­coun­tants and in­vest­ment prop­erty spe­cial­ists. Only then should you think about us­ing your cur­rent as­sets as se­cu­rity for ad­di­tional pur­chases. Good Luck!

Us­ing eq­uity in your home to fund an in­vest­ment prop­erty is a pop­u­lar strat­egy for Aus­tralian in­vestors

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