Beginner’s guide to accessing equity from property

Put simply, if your property’s increased in value, the amount of equity held in that property will have gone up too. You can then refinance your mortgage to access that increased equity, which can then be used to stump up the deposit on another property purchase.

Calculating equity

To work out how much equity you have in your property, you’ll need to subtract any debt remaining on your mortgage from the property’s overall value. So, if your property’s worth $500,000, and you have $300,000 left on your mortgage, then your equity is $200,000.

But it’s not quite that simple when it comes to accessing that equity through your lender. They’ll send a valuer out to your property, and the figure they come up with may not match up to what you think its actual market value is.

Your property’s equity will increase both as you pay off your mortgage and as the property’s value increases. So, if your $500,000 property increases in value by 10% over 12 months that’s an extra $50,000 in equity. Add to this any deduction to the mortgage gained through repayments, and your equity has significantly increased over the year.

Capital growth and equity

Based on a mortgage rate of 6.45%, over a 25-year term

So diligently paying off your mortgage will gradually increase the equity in your home by reducing your debt, but it’s fluctuations in the property’s value that make the real difference. Negative capital growth therefore can drastically knock down your equity level, even if you’re keeping up with loan repayments.

On a property worth $500,000 for example, capital growth of 10% over two years aids equity increases of more than $50,000 per annum. Negative growth of -10% the following year however cuts the total equity increase for the three-year period by more than 50%.

The negative growth effect

Based on a mortgage rate of 6.45%, over a 25-year term

Mortgage broker Michelle Coleman suggests that one strategy to maintain equity increases, even in times of poor or negative growth, is to add value to your property through renovation, subdivision or construction. Adding value in this way will also speed up the rate at which your equity grows during the good times.

“The quickest way to increase your equity is always to try and improve the building, so that it’s worth more even if the mortgage has stayed the same (as in paying interest only). If you’re doing the right things you can increase the value of your property even in a flat or down market,” says Coleman.

Refinancing

Once your property has increased in value, whether that be through capital growth, renovation, or diligently paying your mortgage, it’s possible to use the increased equity as collateral to secure further lending. This involves refinancing your mortgage at its increased value, thus freeing up some of its equity for you to spend on further investments.

Just like your initial agreement, the bank will calculate a loan to value ratio so that they can keep back some equity as security. It’s important therefore to work out exactly how much equity you’ll have at your disposal once the refinance deal’s gone ahead.

“If you’ve got a good property in a good area and the bank is comfortable with you and the location of the property, then they may release 80%,” says George Kafantaris, Metropole’s Queensland director.

For example, if you have a $1 million property and you have a debt of $300k, the available equity is $700,000. If the bank lends 80% LVR, then you can take the usable equity of $560k to put into another property.

Usable equity

Line of credit vs lump sum

One popular way to structure your home equity loan is as a line of credit. What this means is that you’ll be approved a certain credit amount based on your usable equity, but that you’ll only start paying interest on whatever portion of that amount that you decide to spend. Your line of credit can also be linked to an offset account to reduce the amount of interest that your loan accrues, without increasing your repayments. For example if you have $20K in your offset account and have $500K loan, you’ll only be paying interest on $480K. Offset also offers the added advantage of being able to use it as a transaction account so you don’t have to worry about redraw restrictions if you want to access the extra repayments you’ve made on your loan.

You can get your salary paid into your offset account and pay off your mortgage faster or save money on interest, but also have that money there whenever an investment opportunity comes up.

Of course, your line of credit is effectively ‘a massive credit card’ secured on your property. And just like regular credit cards, the temptation will always be there to splash out on luxuries rather than investments.

As an alternative, you may be able to release equity as a lump sum. However, as Kafantaris explains, you’ll then be accruing a significant amount of interest from the

get go.

“The big difference is that if you take out a lump sum you have to pay interest on the whole sum, whereas if you get a line of credit you only have to pay interest on the amount you use,” he says.

Lump sum equity release can be a useful strategy, but only if your investment plans justify the amount that you’ll ultimately be dishing out on interest repayments.

This means you have to be aware that the second you take that money out, you’re increasing your mortgage and paying interest of around 7% on that lump sum. So as long as what you’re spending it on is making you 7%, it can be a worthwhile strategy.

Cross collateralisation

Another means of using your home equity to fund a new investment is to cross collateralise. This is a high risk strategy that involves using the equity from your existing property as security for loans on both properties.

So instead of releasing your equity to use as a deposit for a separate investment property mortgage, quite often with a separate lender, your loans will be linked by the fact that the equity in one property is used as the collateral for both. In other words, if you can’t service the debt on one of the properties, then the bank can repossess both. 

However, in some cases it could be worth taking. For example, if the level of debt that you have on your existing property prevents you from traditional refinancing, then cross collateralisation may provide another means of getting a foot on the property investment ladder.

The downside is it’s a risky strategy. If you’re not sure you’re going to be able to cover both mortgages, then cross collateralisation becomes dangerous.

Do your sums

Before you startbuilding your property empire you’ll need to put together a foolproof budget. This should include a buffer fund to account for future expenses such as interest rate rises, repairs, vacant periods or any shortfall in rent versus fees and repayments.

If you’ve secured $400,000 as a home equity line of credit for example, and want to purchase an investment property worth $500,000, then you’ll need to lay out $100,000 for the deposit. Add to this up to $50,000 in entry fees such as stamp duty and legal costs, and you’re left with $350,000. You might then be tempted to use some of this remaining credit as a deposit on another investment property, but this could leave you with an alarmingly undersized buffer fund.

Assuming your $500,000 property will double in value over the next seven years, Kafantaris suggests that you’d need a buffer of $150,000 to ensure that repayments are met during this period. According to these calculations, the remaining $200,000 in your line of credit wouldn’t be enough to safely finance a further investment on the same scale.

Investment costs

Renovating

If the amount of equity that you can release won’t secure the finance for an investment property purchase, it could be put towards renovations to increase your existing property’s value. In fact, it may even be possible to secure some of the funding for these renovations by refinancing your mortgage based on the property’s post-renovation value.

“You can actually lend against the cost of the renovation if it’s done through a registered builder,” says Coleman. “It’s very similar to a land and construction scenario where you have the plans and the building contract, and the bank will then lend against it. So you can actually reduce the amount of money that you have to put into the renovations if you want to.”

“It has to be through a registered builder and it has to be a contract, but there are plenty of renovation companies that specialise in doing that,” adds Coleman. “And don’t overcapitalise. Keep it within the realms of what’s required in the area. You could have a fantastic mansion in an area where you’re just never going to get that return.”