27 May 2009

Tapping Into Your Hidden Wealth

Equity is a powerful ally, offering investors a golden opportunity to leverage profits from one property into a burgeoning real estate portfolio. But just how do you do it, and what are the risks involved?

Property buyers who have already taken the plunge towards home ownership have number of options when financing another property or growing their portfolio.

As the value of your property increases, the equity you build becomes a vital resource to help you create long-term wealth and security through investment.

What is equity?

The amount of equity you have in your property is the difference between its value (the net amount you can get for it on the market) and the amount of money you still have owing on it. That is, if your property is worth $500,000 and your outstanding mortgage is $250,000, you have $250,000 of untapped equity.

Note that the equity calculation involves the current value of your home. This is likely to differ from the purchase price of your home, as its value is likely to have increased over the years that you have owned it. You don’t need to have paid off your loan completely for this to occur.

Getting started

You need to structure your finances in such a way that accessing equity is easy and efficient. If you lock your loan into a long-term fixed rate, for instance, refinancing that loan to access the equity will cost you thousands of dollars in penalty fees and early-exit charges.

Ideally, you should meet with a finance specialist that understands investing, negative gearing and being able to tap into equity, so they can help you organise the most appropriate financial structure for your investment properties.

Make sure you go to a lender that organises an independent valuer, and then gives you access to the valuation, so that the valuation can be used by several lenders. Ideally, your mortgage specialist would instruct a panel valuer.

How do you calculate how much equity you can access?

Calculating your available equity is quite simple; you just subtract what is currently owed on your property, from its overall value.

In our example, you owe $250,000, and your home valuation came in at $500,000. Using a rule of thumb of 80% of the value of the property, borrowing up to 80% of $500,000 gives you a pre-approved equity limit of $400,000.

If you subtract the balance outstanding of $250,000 from your pre-approved equity limit of $400,000, you have $150,000 in equity available, which could be used for a deposit and costs on other investment properties.

Borrowing up to 80% of the value keeps you out of the realms of lenders mortgage insurance. Borrowing more than 80% LVR will cost you LMI which is designed to the lender, not you the borrower.

How does it work?

Once you know what the figure would be, you can work out the best way to use that equity.

You could buy one investment property, but with our example, you could potentially divide that $150,000 into two sub-accounts and buy two more properties. Account 1 would be your principal place of residence, the owner-occupied property containing a mortgage of $250,000, while two sub-accounts of $75,000 each could fund two new investment properties.

Say you buy an investment unit valued at $300,000, and you borrow up to 80% of the value of that unit.

© Your Mortgage magazine and republished with permission.

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