Today I want to talk about leveraging equity from an existing property to use as a deposit for an investment property. The equity in your property can be calculated by taking the market value of your property and minus the amount you still owe on your mortgage. An example of this is, say you had a property worth $500,000, and you owed $400,000 on your mortgage, you would have $100,000 of equity in your property. Equity can be generated from 3 main sources, the first is by paying down your loan over time, decreasing the amount you owe on your mortgage. The second is by manufacturing equity, this can be done through adding value to your property, in the form of renovations or adding a granny flat, basically anything that’s going to increase the value of your property. The last source is by the capital growth, on average in Australia over the past 25 years there has been an annual growth rate of 6.8% for houses and 5.9% for units. An example of the first scenario could be that you purchased a property 3 years ago, the value of your property has remained at $540,000 over the three years. However, you have managed to pay your mortgage down to $380,000. Technically speaking you have $160,000 ($540,000 - $380,000) of equity in your property. An example of manufacturing equity is say you purchased an older property for $420,000 that needed some work done, you spent $40,000 on renovations, and after 6 months your property got revalued at $500,000. You have now manufactured $80,000 ($500,000 - $420,000) of equity by spending $40,000 on renovations. Lastly, capital growth is the value increase of your property over time, if we take the Australian Average, and you purchased a house for $500,000 3 years ago. Naturally the value of your property should have increased to $609,000, generating $109,000 ($609,000 - $500,000) of equity in your property. There are plenty of Australians out there who have purchased their dream family home, paid off their mortgage over the years, made small renovations as there needed and are most likely sitting on a gold mine of equity. This equity can be used as a deposit for an investment property, However, If you take equity out, you increase the amount of mortgage on your property to a maximum of 80% LVR without paying lenders mortgage insurance. If we take our capital growth example, where the value of the property was $500,000 and has increased to $609,000, on an 80% LVR the original loan amount should have been $400,000. Based on the new $609,000 valuation, at an 80% LVR, we can increase our mortgage to $487,000, freeing up $87,000 of additional funds to use as a deposit for an investment property. You can of course always pay lenders mortgage insurance, sometimes the return is better than the cost. At a 90% LVR, we can increase the mortgage to $548,000 and at 95% it is increased to $578,000 freeing up $148,000 and $178,000 respectively. Using these numbers on a 90% LVR the Lenders mortgage insurance premium would be $14,000, and for 95% it would cost $29,000. So basically, at the highest end of the scale, your paying $29,000 to borrow an additional $91,000. ($178,000 - $87,000) The LMI premium is a one-off, non-refundable fee which is paid at loan settlement. For most lenders, this can be included in the loan amount. Just note that If the LMI premium is added into the loan amount, you will pay interest on the total loan and it will increase the minimum monthly loan repayments. To calculate your LMI premium, multiply your LMI rate by your loan amount. For example on a 90% LVR $578,000 your LMI rate is 3.998% which calculates to be $23,108. Then you need to add the stamp duty on LMI that is applicable for the state that the property is in. I would highly recommend using one of the many online calculators to do this. Once you have refinanced your mortgage, you can withdraw this equity in two main formats, the first is a lump sum payout, where you have the funds deposited into an account or in the form of a check. The second is something called a drawdown where you can borrow the funds as needed, this scenario can be arranged in the form of a drawdown facility or offset account. This works well with renovations because you can pay as you go, only paying interest on the funds as you use them, not all at once as you would when you take a lump sum or check. I will use an offset account as an example here, an offset account is a separate account tied into your mortgage, however, any funds that sit in this account are viewed as funds offset against the loan. Meaning the amount of calculated interest is reduced by the amount sitting in the offset account, however, you can freely deposit and withdraw these funds as you see fit. Taking our 80% LVR example where we can increase our mortgage to $487,000, pulling out $87,000 of equity, with an offset account setup, we can deposit the full amount of into the offset account. Because we now have the $87,000 sitting in the offset account, it would be deducted from the total loan amount, meaning the interest would be calculated on $400,000 ($487,000 - $87,000) rather than the full $487,000. We can then withdraw the $87,000 when we are ready to use as a deposit for our next investment, and the calculated interest isn’t increased until we withdraw the funds. Lenders will need to know the reason for borrowing the equity, for an investment property they will require an application, valuation of your property to determine its value and evidence for the ability to pay the new loan. As a final note, avoid cross collateralisation here, which you generally can get trapped in when using the same bank for both property loans. It is best to use the offset account from your first home with the original bank, and withdraw it as a deposit for your second property with a separate bank, you don’t want these properties tied into the same loan. As always, seek your own professional financial advice for your current situation.

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