For seasoned investors, home equity is commonly used to further grow investment property portfolios. But what is home equity and how is equity used to buy a home or investment property?
What is home equity?
Home equity is the difference between the current market value of your home, minus how much is remaining on the loan. Home equity can be used to buy a home or investment property, without the need to save for a cash deposit. Using equity allows you to buy a second property with no cash deposit. However, it’s important to understand how home equity is calculated, and the difference between total equity and usable equity.
How to calculate total equity
A common question that gets asked is how much home equity do I need before I buy an investment? To answer that, let’s look at an example. Say your home is worth $400,000, and you still owe $100,000 on your home loan. Your total equity is $300,000, however, it’s important to note that equity is reliant on the market value of your home, not the purchase value. As most markets continually fluctuate, so will your equity. There are several pathways to get a read on the market value of your home through gaining a property valuation. These are typically carried out through your bank, a local real estate agent or a professional valuer.
How to calculate usable equity
To use equity to buy a home or an investment property, banks will first calculate your usable equity. Generally speaking, most banks will typically lend up to 80% of the market value of your home, minus how much is remaining on the loan. The remainder is your usable equity, however, there are still several additional factors that banks may consider before arriving at a final figure, including
Using the example above:
Property market value = $400,000
80% of market property value = $320,000
Amount owing on loan = $100,000
Usable equity = $220,000 ($320,000 – $100,000)
Lastly, you’ll need to account for costs associated with purchasing a property and take those away to determine a final usable equity figure. These costs often sit around 5% of the purchase price.
How is equity used to buy a home?
Once the total equity has been calculated and a final value has been arrived at, you can then discuss with your bank or financial lender how to use the equity to finance your next home or investment property. Your current property will become security against the new debt.
How else can equity be used?
Home equity doesn’t always have to be used to invest in more property. There are several other uses for your home equity outside of buying another property. It can also be used to:
- Renovate or upgrade your home
- Help you into a business
- Buy a car
- Go on holiday
It’s always highly recommended to speak to a financial advisor or industry professional to find out what options are available to you.
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