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How to use equity to buy property

March 29, 2022
by
Craig Gibson

If you own your own home and have been making repayments for some time you’re likely to have built equity, or value, in the property. Depending on how much this is, you could use your equity to secure a home loan, buy an investment property, or renovate your home. 

Sometimes the concept of property equity and how it is calculated can be a little confusing. So to help you on your way, here’s a no-fuss guide to what it is and how it can be used to take a step-up the property ladder.

What is equity? How is it calculated?

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 $850,000 and you still owe $200,000 on your mortgage, the equity would be $650,000. As you can see, if property prices are rising and you have been making all your mortgage repayments, the equity (or value) in your home could be a considerable amount. 

Unfortunately home loan providers don’t allow you to use all the available equity in your property to secure a loan - their calculation is based on ‘usable’ equity.

So what is usable equity?

Usable equity is the portion or percentage of your total equity that a lender will allow you to access. The standard calculation they use is to work out 80% of your total property value and subtract the remaining balance of your home loan. 

This is to protect themselves in case you can’t afford the payments on the new loan. Some lenders may allow you to access more of your available equity if you agree to pay lenders mortgage insurance (LMI), but this does make the loan more expensive for you. 

Example: Using the values in our example above, this is what your usable equity would be:

80% of $850,000 = $650,000 – $200,000 = $450,000 usable equity.

Let’s now answer a common question: can you utilise usable equity to buy a house with no deposit?

Read: Doorsteps guide to selling your home

Can you use your usable equity to buy a house with no deposit?

The short answer is, yes - the equity in your home can be used instead of a cash deposit to buy a property. The equity in your existing property is essentially acting as security on the new debt.

This will depend on a number of factors, including if your property has risen in value enough to provide you with enough equity. You also will have reduced what you owe on your home loan, by making regular repayments toward the principal and interest portion of the loan. 

Ultimately your lender will calculate your usable equity and assess your borrowing power before deciding if you are a suitable candidate for a new loan. 

Read: Doorsteps guide to buying a home

How do I use equity to buy property?

There are three main options when it comes to using the existing equity in your home to buy property:

Home loan top up

As the name implies, a home loan top up simply increases your existing home loan limit, and  essentially increases the debt on your current home loan. Once approved, your existing lender will simply deposit the agreed sum into your account as cash, and you use these funds to purchase the new property. 

Be aware that your monthly repayments will increase, so you will need to be able to afford this. Your loan term is also likely to increase, meaning you will be paying back the loan for longer. This option may not be available on all home loans, so check with your lender to confirm this. 

Use a mortgage repayment calculator to work out how much you can afford, and what your repayments could be.

Cross-collateralisation

Cross-collateralisation is a strategy where your existing property is used as security or collateral, and it gets added to the new property’s loan. There are two mortgages or home loans in this scenario:

  1. Your original home loan on the existing home.
  2. The new home loan secured by your existing home.

The pro of this option is you save on fees, but if you cannot make repayments, both properties can be repossessed. It is also more complicated if you decide to sell one property, as you have to apply for a fresh loan for the one you are keeping.

Use a supplementary loan account

A supplementary loan account is simply another home loan specifically to finance your new property. The big advantage of this is that you can choose loan features - like a low-rate, interest-only product that minimises your monthly repayments. This option also makes sense if you want to limit your outgoings and leverage a rising market.

But is using equity to finance your next property a good idea?

Doorsteps guide: Bridging loans

Does it make sense to buy a house with equity?

In most cases using equity is a great way to leverage and a popular option to invest in the property market immediately, without the requirement to save for a deposit. It can also help you avoid paying Lenders' Mortgage Insurance (LMI). 

Like any financial decision, you need to weigh up the pros and cons - based on your personal financial circumstances. 

Key considerations to keep in mind when using equity to buy property

If you decide to use the equity in your home to finance your next property purchase, be aware of the following:

  • You are effectively increasing your debt, and need to be able to afford the extra expense of a new loan.
  • Your regular repayments are likely to increase, so you need to budget for this extra cost.
  • You will be extending the term or length of your loan, and the amount of time you will be liable for making repayments.
  • If you cannot afford the repayments the property will be repossessed. 

This is why it’s so important to do your research and budget very carefully. You need to know what you’re in for, especially if interest rates rise or if your circumstances change. We recommend speaking to a broker who will be able to walk you through multiple scenarios to work out what you can afford and whether using available equity is the right option for you.

Tips for increasing your property equity

There are a number of ways of increasing the equity in your home, including:

  • Making additional repayments towards your home loan, so you reduce the term of your loan and save on the amount of interest you pay.
  • Making improvements to your property via well-planned renovations and home improvements - like revamping your kitchen and bathrooms, but be wary of over-capitalising.

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