Equity. It’s a word you hear dropped into conversation at dinner parties, talked about earnestly at family gatherings and chatted about over the office water cooler. If you’re one of the many Australians lucky enough to have equity in your home, it’s seen as a great way to potentially build your wealth and create a more comfortable life.
The reason equity has become so talked about is due to the solid long-term gains in Australian home values. Across the nation’s state capitals, through peaks and troughs, property prices have risen 5.1% on average annually since 20051. And if you look at CoreLogic’s data for the last 25 years2 it’s even more impressive, with the Australian median house price value growing by 412% (over the same time the ASX All ordinaries rose by a substantially lower 261%).
So there are many homeowners have equity in their home that they can potentially use to assist them to invest in another property. You may be one of them. In fact, you may have more equity than you realise.
But at the same time, equity is no wealth magic wand. Before you invest in property you need to do the sums, develop a tax strategy with your accountant and see if you are in a financial position to both service the loan and afford the extra costs.
What is equity?
Equity is the difference between the current market value of your home and how much you owe on your home loan.
Let’s say your home is worth $400,000 and you still owe $220,000 on your home loan. Then your equity would be $180,000.
Lenders, however, will typically only lend against 80% of your home’s current value. This is to allow for any dips in house prices. So, taking the example above, the way to calculate your home’s usable equity is:
Home’s value: $400,000 x 0.8% = $320,000
Outstanding loan: $220,000
Useable equity: $320,000 – $220,000 = $100,000
So that’s your useable equity. The general rule of thumb is that you may be able to borrow up to four times your useable equity for an investment property. So, in this instance you may be able to borrow $400,000 – with your useable equity basically acting as your deposit.
But this is, of course, subject to your ability to afford the loan. It’s not a given that you can borrow against it. Your lender will need to be comfortable you can afford the extra financial commitment and will take your income, job status, current savings, financial commitments, living expenses and credit history into account, as well as your equity position.
To get an idea of the equity you hold in your home, use one of our free ING property reports to get the estimated value of your current home. You can use this to make a rough calculation of your useable equity using the formula above. Or call one of our home loan specialists on 1800 100 258. They can help calculate your equity and how much you could expect to lend with the help of our borrowing power calculator.
Working out your budget
Accessing equity is one thing. Whether you can realistically afford all the costs of an investment property is another. Just because the bank will lend you money, doesn’t mean you should borrow it.
So once you’ve done your equity calculation, sit down and crunch your numbers. Because in the end that’s what property investment comes down to – cold, hard maths.
Let’s look at ongoing costs first
Imagining you can borrow four times your useable equity amount as outlined above, first visit our repayment calculator to see what your average loan repayments would be on that amount each month.
Then pick a couple of areas where you want to purchase an investment property and find what you can buy for the price – and look up the monthly rental return on those properties you’ve found.
Once you have those two figures do this simple sum:
Your monthly repayments – minus your expected rent = weekly costs (or gains if you plan to positively gear)
Plus add some estimates for other ongoing costs people often forget about:
- Council and water rates
- Home insurance
- Real estate property management fees
- Strata levies if you buy an apartment
- General maintenance and repairs.
- Expect occasional vacancies, so allow for a few weeks with no rent each year
You may be able to claim some of these expenses and a portion of the loan interest as a tax deduction, if you are negatively gearing and making a loss on the property. You will need to sit down with your accountant to devise your strategy and assess your individual situation and needs.
Nonetheless this simple budget gives you a general outline of what your monthly investment outlays will be and what sort of impact that might have on your household cash flow.
There are also many costs associated with purchasing the property. Stamp duty is the most significant. It varies depending on which state the property is in and the purchase price. Our stamp duty calculator can help you see how much you will need to pay.
- legal and conveyancing costs
- accountant’s advice
- pest and house inspections
- mortgage insurance
- land tax.
You will need to allow around 5% of the purchase price to cover the stamp duty, plus these expenses.
Ask for a new valuation on your property
If you’ve done all the budgeting and want to take the next step, then it’s time get things done officially. Which means you need to ask your lender to do a new valuation on your property. From there they can calculate your equity and tell you what you can borrow.
It’s a good idea not to use every last cent of your equity. Because it can be a fantastic buffer and back-up if something goes wrong, not just for your investment property, but for the home you live in and that loan too.
Even if don’t end up investing in another property, the valuation can be the starting point for using your equity for other things – like renovating your home, buying a car, taking an overseas holiday or even starting a business.
Talk to a specialist
There’s quite a bit to consider with property investment. So if you would like to talk to an expert, our home loan specialists are here to help – all with no obligations, just friendly support. They can help you find out how much equity you can use towards an investment and how much you can borrow.
- CoreLogic RP Data March hedonic home value results April 2015
- CoreLogic ‘25 years of Housing Trends report’
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