If you’re looking to build your property portfolio, unlocking the power of equity can help get you there.
Ways to build equity
Simply put, equity is the difference between the market value of your home and how much you owe to pay it off.
For example, if your home is worth $750,000 and you still owe $500,000 to your lender, you currently have $250,000 of equity.
Generally, the equity in your home will grow over time. However, there are a few ways you can grow your equity sooner.
Increase the value of your property
The more your home is worth, the more equity you’ll build. Many investors take equity building into their own hands through renovations and home extensions. A re-do of an outdated kitchen, or transforming your home from a two bedroom to a three, could add significant value to your property.
While renovating can be an excellent equity building strategy, it may not be the right option for everyone. It’s best to consult with a lending expert to help you understand the market potential of your current property.
Maximise your repayments
Another way to build equity is to ramp up the amount you’re contributing in repayments each month. You can adjust your repayments by:
- increasing the amount you pay each month, or,
- shortening your repayment schedule from monthly to fortnightly, or even weekly.
By increasing your repayment amount or frequency, you’re actively reducing the amount you owe to your lender along with the overall length of your loan term. This means you’re getting closer to owning your home outright, while also increasing valuable equity.
Make a large deposit
While it may be tempting to spend a large cash windfall on a luxury purchase or that dream holiday, you could consider using that extra cash to build more equity.
A large deposit into your overall home loan can help to drastically reduce the amount of interest you’re paying yearly on your loan. It will also contribute to shifting your loan to value ratio (LVR) more in your favour.
For example, if you have a current loan of $250,000 and your home is worth $750,000, your LVR currently sits at 66 percent (500,000 / 750,000 = 66 percent). However, if you’re able to put an extra $100,000 into your property (say, from an inheritance, or rewards from a good budget), then your LVR would drop considerably to 53 percent (400,000 / 750,000 = 53 percent). A lower LVR will make you a much more attractive loan prospect for both your current or potential new lender. Most lenders will allow you to access some or all of your equity once your LVR is below 80 percent.
It’s best to check the type of home loan you have before you make a large lump sum deposit. If you’re on a fixed rate, you may incur an additional charge if you pay more than the Pre-payment allowance in excess of your monthly payment, or if you repay your loan in full during the Fixed Interest Period.
4 ways to use your equity
Once you’ve successfully built up enough equity to think about a second property, you’ll need to apply a strategy to access and maximise it.
Refinance your home
Many investors turn to refinancing to effectively evaluate their current property and negotiate a new mortgage to cover their home and additional property.
While refinancing with a new lender will take into account any available equity you’ve built up, they’ll also consider other risk factors such as income, any other debts and general serviceability of the now larger loan.
If your loan has redraw capability, you may be able to use funds you’ve allocated to your loan for other investments, such as a deposit on that second property. When used well, redraw facilities can help to minimise the amount of interest you accumulate per month while also offering flexibility.
For example, if you have a $150,000 loan and you pay off $50,000 of that loan, then – provided you have redraw capability – the loan will reduce to $100,000. If you choose to take that $50,000 back out of the loan, you may be able to take advantage of certain tax deductions (depending on if you’re using the funds to go on holiday compared to investing in a new property).
Redraws can be an effective way to compel you to save more money on top of your regular home loan repayment, minus the ease of accessibility that comes with an offset account. Make sure you check the type of loan you’re on before you redraw - you may incur an additional charge if you’re on a fixed rate.
Line of credit
A line of credit is an agreement between you and your lender that provides you with access to a certain amount of funds whenever you need it, like when you wish to renovate or purchase another property. A common type of home equity loan, a line of credit operates in a similar way to a credit card. Since these funds are normally secured against your home’s equity, the more you’ve built up in your primary home kitty, the more favourable your line of credit rate and terms will be.
A reverse mortgage is a great option to unlock the wealth in your property after retirement. This type of loan allows you to borrow against the equity you’ve built up, similar to a line of credit. The major difference is you won’t be required to make repayments while you live in your home. However, you will have to repay the loan in full (including interest and fees) when you do sell the property.
Be aware of the risks
As with any major financial decision, it pays to be aware of the potential risks involved. Regardless of how you use the equity you’ve built to purchase another property, you may need to consider any or all of the following:
- Periods of time with no tenants living in the property you’re renting out.
- A safety net that’ll allow you to handle two mortgages should your financial circumstances change.
- Your ability to handle changes to a variable rate that can fluctuate across multiple properties.
- The unpredictability of the housing market should you need to sell.
Explore your equity options
At Suncorp, we know that buying a second property requires a lot of research and decision making.
That’s why our experienced Financial Planners are here to help you make the best decision for your financial future. If you’re ready to expand your property portfolio, we’re here to talk to you through the details.
Information is intended to be of a general nature only and any advice has been prepared without taking into account any person's particular objectives, financial situation or needs. You should make your own enquiries, consider whether advice is appropriate for you and read the relevant Product Disclosure Statement or Product Information Document before making any decisions about whether to acquire a product