Using equity in your home to buy a rental property
If you already own a home, you may have built up equity over time. Equity is the difference between the current value of your property and the amount you owe on your mortgage. Leveraging this equity can be a powerful strategy for financing a rental property.
There are two ways to build your equity.
- The value of your home increases, either through market changes and/or home improvements.
- By paying off your principal (the amount you’ve borrowed) or reducing the borrowing limit of your home loan over time.
It’s important to note that the bank won't let you use all of the equity you have available, they will usually only lend to a maximum of 80% of the value of owner-occupied property, and up to 70% of any investment property's value. That's why it's essential to work with a Mortgage Adviser to explore the best options for leveraging your equity effectively and structuring it correctly.
Deposit requirements for rental properties 💰
When purchasing a rental property, the banks generally require a significant deposit these days. While the exact deposit amount may vary, you will need at least 30% of the property's purchase price. If you're considering buying a new build as a rental investment, there are specific requirements you may need to meet. It's best to discuss this option with an experienced mortgage adviser.
Loan options 💲💲💲
The most common way to use the equity in your home for a deposit on a rental property is by securing pre-approval for additional lending. This helps you understand your borrowing capacity and positions you to act when the right property becomes available. Talk to your adviser to explore options that suit your financial situation and goals.
A revolving credit facility is like a large overdraft that gives you the flexibility to move quickly on purchasing a rental property as the “cash” for the deposit is available to draw upon immediately.
The second step is to ensure you’re pre-approved for the balance of the purchase price before you start property shopping. Your adviser will help you explore the best lending structure for your needs, whether that means staying with your current lender or considering other options to suit your financial goals.
Let's look at an example to simplify things:
🏡Your home is worth $1,000,000.
💲You already have a mortgage of $550,000.
😊Therefore, you have equity of $450,000.
If all the figures stack up in terms of serviceability, the bank will most likely allow you to borrow up to 80% of your home's value, which in this example would be $800,000 (80% of $1,000,000).
Given that you already owe $550,000 on the mortgage you will have what we call “usable equity” of $250,000 to use to fund the deposit on a rental property,($800,000 - $550,000 = $250,000).
As you will require a deposit of at least 30% on the new rental, you could possibly purchase something for up to $700,000 as the deposit required will be around $245,000. This would also leave you with a bit of a buffer to pay for things like building inspections, legal fees and any minor cosmetic touch-ups required on the property before you rent it out.
All of this of course assumes that you can afford to actually service this level of borrowing. That's where working closely with your Mortgage Adviser can help you work out the best strategy for buying a rental property and make sure you are set up correctly from the start so you can keep growing your property portfolio.
Separating your properties across different lenders
If you have more than one investment property or plan to in the future, then diversifying your portfolio by using different lenders can provide you with flexibility as the lending market changes. It also splits your risk.
For example, if you have multiple properties and mortgages with one lender and you decide to sell one of those properties, the lender may require a complete review of your entire portfolio. This review will be based on the current bank criteria and policies so if the lender's credit requirements have changed since you took out the original mortgages, they may demand a larger repayment from the proceeds of the sale than what was originally required.
So if you intend on growing your property portfolio make sure to get this set up correctly in the first place to avoid unnecessary stress.
What if you want to upgrade to a new home and keep your old one as a rental? 🤔🗝️
In the current market, we have had clients taking the opportunity to upgrade to a new home and keep their existing home as a rental property. The hurdle that most people run into is that once the bank is advised that your current home will be turning into an investment property they restrict the loan-to-value ratio (LVR) to 70% - meaning that the lending on that property can not exceed 70% of the property's value.
This can make things difficult when you are looking to use the equity in your existing property to buy your new home and can put a dampener on the journey to getting into your next home if you don't set things up properly beforehand.
It's important to get the right advice from the moment you are thinking about this scenario. A Mortgage Adviser will have access to specialist lenders that embrace these situations and don't restrict you from using your equity in this way.
Financing a rental property requires careful planning, research, and expert guidance.
By understanding deposit requirements, leveraging equity and exploring loan options, you can maximise your returns and achieve long-term financial success.
With the right approach and support, property investment can be a rewarding and profitable endeavour.
As always, talking to your trusted Mortgage Adviser is the best place to start.
I can help you navigate the way, so get in touch today!
Cheers,
Karen