Unlocking Investment Strategies With Equity

Using equity to invest is a smart way to build your property portfolio without having to dip into your savings. Equity is the difference between the market value of your property and the amount you still owe on your home loan. For example, if your home is worth $500,000 and you have $300,000 left on your home loan, your equity is $200,000. This equity can be used as security with most lenders, allowing you to borrow against it to fund investments. However, lenders will typically only lend you 80% of the value of your home minus what you still owe, which is considered your usable equity. This means that if your home is valued at $500,000 and you owe $300,000, your usable equity is $40,000 ($500,000 x 80% = $400,000 - $300,000 = $100,000).

You can use your equity to invest in a number of ways, such as buying an investment property, taking out a line of credit, making renovations, or investing in shares or managed funds. It's important to note that using equity to invest does carry some risks, such as increasing your overall debt and monthly repayments. Seeking advice from a financial advisor or mortgage broker is recommended to ensure you understand the risks and make informed investment decisions.

Using equity as a deposit for an investment loan

Home equity is the difference between the current market value of your property and the amount you still owe on your mortgage or home loan. For example, if your home is worth $500,000 and you owe $320,000 on your mortgage, your equity is $180,000.

Calculating Usable Equity

It's important to note that you can't use all of your equity to buy a new property. Lenders will typically lend you up to 80% of the value of your home, minus the debt you still owe. This is known as your usable equity.

Using the previous example, if your home is valued at $500,000, 80% of that value is $400,000. Subtract your mortgage of $320,000, and you're left with $80,000 in usable equity.

Using Equity as a Deposit

You can use this usable equity as a deposit for an investment loan. Typically, you need a 20% deposit for a home loan. So, with $80,000 in usable equity, you could purchase a property worth $400,000. Keep in mind that you will also need to cover additional costs such as stamp duty and settlement fees.

Benefits of Using Equity

Using equity to invest in property offers several benefits. It allows you to unlock the value in your home without dipping into your savings. It can also help you secure a better interest rate and avoid paying Lenders' Mortgage Insurance (LMI) if you want to make a deposit lower than 20%.

Considerations and Risks

While using equity can be a powerful tool, there are some considerations and risks to keep in mind. Firstly, the property you're taking equity from will become additional security for your new loan, which may impact your flexibility when making investment decisions. Additionally, it's important to maintain a sufficient buffer and not use all your equity, as this can help you prevent borrowing money in case of emergencies.

Before making any financial decisions, it's always recommended to seek professional advice to fully understand your options and the potential risks involved.

Taking out a line of credit

However, it is important to note that interest is charged as soon as you borrow any money, and the interest rate is typically variable, meaning it can increase at any time. You will also usually have to provide an asset as collateral for the loan.

A line of credit can be a good option for those who need to cover unexpected expenses or finance projects with unclear costs. It can also be useful if you need to make a large purchase but are unsure of the total cost. For example, a line of credit could be used to fund a home improvement project or to buy an investment property.

When taking out a line of credit, it is important to consider the potential risks. These include high-interest rates, late payment fees, and the possibility of spending more than you can afford to repay. It is also important to shop around and compare interest rates and fees from different lenders before taking out a line of credit.

Additionally, when using a line of credit to invest, it is crucial to ensure that you have sufficient funds to cover any potential losses. Investing carries inherent risks, and you should never invest more money than you can afford to lose.

Using equity for deposit bonds

A deposit bond, or deposit guarantee, acts as an insurance policy that assures the vendor that the purchaser will pay the deposit at settlement. It is a substitute for a cash deposit, and can be used when exchanging contracts and at auctions.

There are several benefits to using a deposit bond. Firstly, it is a cheaper alternative to bridging finance, giving you reassurance that your new property will be held until you settle your own property sale. Secondly, since no cash is required upfront, your savings can remain intact and continue to earn interest. Thirdly, a deposit bond can be used at multiple auctions, as the vendor and property details can be left blank. This is especially useful if you are attending multiple auctions. Lastly, a deposit bond can be useful if you are buying a property off-the-plan, as it gives you extra time to save and earn interest on your savings.

However, there are a few things to keep in mind. Some vendors may refuse to accept a deposit bond, especially if they need early access to the deposit to secure a new home for themselves. Real estate agents may also refuse to accept deposit bonds, as they are typically paid their commission from the deposit and may want to get their payment as early as possible. Therefore, it is important to always check with the vendor, real estate agent, or developer about the use of a deposit bond before obtaining one.

Renovating your home

Home equity is the portion of your property that you own outright, without any outstanding mortgage or loan balances. It is the difference between the current market value of your home and the amount you owe on your mortgage. For example, if your property is valued at $500,000 and you have a mortgage balance of $300,000, your home equity is $200,000.

There are a few ways to access the equity in your home to fund your renovation:

• Refinancing: You can refinance your existing mortgage for a higher amount and receive the difference in cash. This option allows you to take advantage of potentially lower interest rates while accessing the funds needed for your renovations. However, refinancing may come with additional fees and could extend the repayment term of your mortgage.
• Home Equity Line of Credit (HELOC): A HELOC provides you with a line of credit based on the equity in your home. You can borrow as needed, up to a predetermined limit, and only pay interest on the amount you use. This option offers flexibility and is suitable for phased renovation projects or ongoing expenses. However, interest rates on HELOCs can be variable, meaning they may increase over time.
• Home Equity Loan: Also known as a second mortgage, a home equity loan provides a lump sum of money based on your home equity. You receive the funds upfront and repay the loan in regular instalments over a fixed period. This option offers predictable stability with a fixed interest rate and consistent monthly payments.

When deciding how to use your home equity to renovate your home, it is important to consider a few key factors. Firstly, ensure that you have built up sufficient equity in your property. Lenders generally require homeowners to have a minimum of 20% equity before considering a home equity loan or line of credit. Additionally, evaluate your ability to repay the loan by taking into account your income, expenses, and other financial obligations.

It is also crucial to assess the potential increase in your home loan and create a detailed renovation plan to obtain accurate quotes from contractors or suppliers. Factor in all costs, including materials, labour, permits, and any associated fees. Once you have an accurate estimate, you can assess the financial impact of increasing your home loan and ensure that the increased monthly repayments fit comfortably within your budget. Remember to account for any potential interest rate fluctuations and plan for unforeseen expenses during the renovation process.

By following these steps and working with a credit finance professional, you can make an informed decision about using your home equity to renovate your home, achieving your renovation goals while safeguarding your financial well-being.

Investing in shares or managed funds

There are two main types of funds to consider: actively managed funds and passively managed funds. Actively managed funds involve a portfolio manager who actively researches, analyses and selects stocks with the goal of outperforming a benchmark index, such as the S&P 500. The success of an actively managed fund largely depends on the fund manager's skill and decision-making ability. Passively managed funds, on the other hand, include index funds, which aim to replicate the performance of a specific market index. For example, an S&P 500 index fund would hold the same stocks in the same proportions as the index itself. Passive fund managers do not try to beat the market; they simply aim to match it as closely as possible.

When investing in a managed fund, you hold units in the fund. The unit price, or value of each unit, reflects the market value of the assets held within the fund at any given time. Your units can increase or decrease in value daily, depending on the rise and fall of the assets' market values. Apart from capital growth, you may also earn income in the form of dividends or interest when the fund makes profits from its assets.

There are several benefits to investing in managed funds. Firstly, they provide access to a diversified range of companies, industries and countries. Secondly, the entry cost tends to be lower than buying shares directly, as the pooled capital is spread across different investments. Thirdly, managed funds can help to mitigate the risk of certain assets performing poorly. Finally, relying on a professional fund manager to look after your money can be beneficial if you don't have the time, knowledge or skills to make informed investment decisions.

However, it's important to remember that there are fees involved when investing in a managed fund, and these fees can vary greatly. Actively managed funds typically charge higher fees than passive funds. Additionally, actively managed funds do not always outperform the benchmarks they aim to beat, and there is a risk of losing money. Therefore, it's crucial to determine your investment goals and understand your risk appetite before investing.

Frequently asked questions