The latest news and tips to fast forward your financial future.
Equity: Access it or lose it?
If you own a property in Sydney or Melbourne, chances are, it’s racked up massive growth in value during the past couple of years. With your newly gained equity, you’re now a whole lot richer – at least on paper.
But don’t assume that this added equity lasts forever. As the market slows down and values start to plateau or drop, you’ll find your equity could also start to dwindle. Therefore, you want to make the most out of your newly acquired wealth while you have it.
But to access it, you need to either sell or take up a new loan to unlock the equity. If you don’t have any compelling reasons to sell, you could consider opting for the latter.
"You need to sell or take up a new loan to unlock the equity in your home."
By taking up a loan against your equity, you’re able to hold onto an income-producing asset that’s growing solidly while building your portfolio.
What is equity?
In simple terms it’s the difference between the current value of your property minus the mortgage on this property.
- Current property value: $600,000
- Mortgage: $300,000
- Equity gained: $600,000-$300,000= $300,000
In theory, you have $300,000 equity that you can access. But in reality, you can tap less than that.
That’s because the banks will only lend a portion of the property value – at many banks, this amount is 80%. So in this case:
- 80% of the property value: $600,000 x 0.8=$480,000
- Mortgage: $300,000
- Accessible equity: $480,000-$300,000 = $180,000
As you can see, it’s considerably lower than the theoretical amount, but this is still substantial amount. You could use this equity as a deposit for another property, provided you have the income to support it.
How to lock in your equity
When it comes to accessing your equity, there are generally two financial options: topping up your existing mortgage or taking up a line of credit.
Loan top up
This essentially means you’re using your existing loan to borrow by adding to it. It’s a little bit like increasing your credit limit on your credit card.
Advantages can include not having to apply for a new loan with a new lender as all your loan documents are already on file. You may also save some cash on loan establishment fee or monthly fees. Generally, topping up a loan is the easiest way to access your portfolio.
The downside is that your repayments will likely become significantly higher due to your bigger mortgage. The banks are also now quite strict with their policies and some only allow top ups for investment purposes.
Line of credit
A line of credit (LOC) is a separate loan taken against the property and it works a little bit like a giant credit card limit, where you only pay interest on the money you spend. They are favoured by many investors because of their flexibility.
The downside is that it can have higher interest rate compared to a standard variable rate.
Top tips for accessing your equity
Ensure your property is well-prepared for valuation
Before you can access equity, the banks will arrange for a valuer to do a valuation on your property.
Once the valuation comes back, the lender will then use that to assess how much they are prepared to lend.
Therefore, you want to make sure you’re getting the best valuation possible by ensuring there are at least three recent sales that are similar to your property and they have achieved good sales price. You should also make sure the property is well presented.
Ensure your documents are current
You could be able to significantly fast-track your loan application by having these documents ready:
- Three most recent pay slips
- Two years’ worth of tax returns if self-employed
- Employment contract showing your level of employment.
Be clear about the purpose of the loan
Lenders want to know what you want to do with the loan. Be clear and specific about your purpose. If you’re buying another property, they want to see the Contract of Sale. If you’re using it for something else, be aware that lenders may not allow you to access all your equity amid the new tighter lending environment.
Buy a solid property that lenders like
This is not only smart investing but also practical. If the lenders are not willing to lend against a property, this usually means it’s too risky for them. Therefore, aim to buy a property with solid fundamentals so that the numbers stack up.
Don’t borrow too much, even if you can
It’s easy to overextend yourself when there’s a large amount of equity waiting to be accessed. But there are big risks involved, because the bigger the loan amount, the higher your repayments are going to be. There’s also an added risk of falling into negative equity. This is when your debt is higher than the property value as a result of falling prices.