Equity is the value of an asset
minus any debt outstanding.
In the case of property:
In the example above the $500,000 property was purchased with a 20% deposit ($100,000). Over time the property has appreciated, and the debt has been paid down, giving the owner equity of $600,000 – $350,000 = $250,000.
Equity in this particular property is now 42% ($250,000 / $600,000)
If you have equity,
you have the opportunity to use some of that equity
as security to purchase
an investment property.
Equity is calculated on the current market value of your home (or investment property) minus what you owe the lender. As an investor, you can access up to 80% of your current property’s equity (without the need to take out Lenders Mortgage Insurance)
In the example above, the home was purchased for $500,000 with a 20% deposit ($100,000). Over time the property has appreciated and now has a market value of $600K (determined by a professional valuer’s report arranged by the lender) and the loan has been reduced to $350,000.There is now total equity of $250K.
However, the available or useable equity is calculated after retaining 20% of the market value ( $600K x 20% = $120K) and taking that away from the total equity $250,000 – $120,000 = $130,000
(Retaining 20% in the property avoids incurring LMI on the property offered as equity)
This $130,000 can then be used as security for another property.
Usually, the lender will then allow you to borrow 100% of the purchase price of the investment property plus your costs. This means there can be no cash outlay required.
Assuming once again, the homeowner would like to avoid LMI, they would be able to purchase property up to the value of approximately $500,000. (20% of $500K = $100K and this then leaves them $30K for costs)
However, given the variability of valuations, it would be wise to stay within their capacity and perhaps purchase a property for around $450,000 – allowing them to keep a buffer in reserve.
Borrowing capacity does not necessarily equal comfort range. The investor needs to decide what is sustainable and comfortable, long term, for them.
This can be verified by having the cash flow figures worked at different purchase prices and stress-tested for changes in interest rates, rent returns and vacancy rates etc