What Happens When You Use Equity to Buy a Property?

Once you have equity in your home, you can use it to build your personal wealth. The trick is to know how to use it wisely.

How to build (and use) home equity

Home equity is the difference between what your home is worth and what you owe on your mortgage. Your home equity increases organically in one of two ways:

• paying off your mortgage – also known as paying down debt. The smaller your mortgage, the more equity you have in your home.
• capital growth – as the value of your home increases, your equity grows.

Homeowners can use home equity to fund major home renovations, pay down or consolidate other debts or plan for their retirement. You can also use your home equity to sell your current home, perhaps upgrade to a larger or more expensive home, without having to find a deposit.

However, many investors use their equity to buy second and subsequent properties. You may want to buy a new investment property or move to a new property and rent out your current home.

Why using equity is a good idea

Using equity is a great way to build your property portfolio, increase your overall wealth and make the leap from property owner to property investor all in one go. Equity is a valuable and often underutilised asset. Many people have access to it but are unsure how to use it to its best advantage.

Depending on the level of equity in your current property, you may not need to use any of your own cash for a deposit on the new purchase. Like many people, you probably saved long and hard to buy your first home. Yet, once you’ve built up home equity, the path to that second property is much easier. This means you can buy an investment property sooner and in turn, build more equity.

• Useful reading: What to know about financing your investment property

How to access your equity

Just as there’s more than one type of investment property, there’s more than one way to access your home equity. With so many available options, you need to make sure you’re using the one that works best for you.

• Line of credit – if you want some flexibility with your additional lending, a line of credit, rather than a traditional home loan, is the way to go. But be aware, you’ll have to pay for this flexibility as banks and lenders may charge a higher interest rate for these types of facilities.
• Refinancing – you’ll usually need to use the same lender or refinance the existing home loan when you apply for the second loan. Banks prefer to be the first mortgagee so refinancing may mean swapping banks.
• Cross-collateralisation – this is just a fancy finance term when, to access the equity from the first property, both properties will be used to secure both debts.
• Reverse mortgage – if you’re over 60 and need some money, a reverse mortgage allows you to borrow against the equity you hold in your property. You don’t make loan repayments while you’re living in the property.

Weighing up the risks

As with any investment strategy, you need to be aware of the risks involved. And cash flow, tax issues and retirement plan all need to be taken into consideration.

If you sell a property that is cross-collateralised, the remaining property will need to be able to support the debt that is left.

If you take out a reverse mortgage and you’re not the sole owner or occupant of the property, the other person may need to leave if you sell or die.

Home equity is a valuable asset when used wisely, so make sure you understand what option will work best for you.

Want to make your home equity work for you? Yellow Brick Road mortgage brokers are here to help. Contact us today.