So you’ve had your home for a while now and you just found out you have something called equity – that is the value of your property minus the loan amount owing. But did you know that you could use this to help get you your first investment or to allow you to build up your portfolio?
How does refinancing to invest work?
As with the usual refinancing process, when you refinance to invest, you’ll have the option to find a lender who is offering you a competitive rate or features while getting the chance to save money. However rather than just refinance to save money, you’ll be refinancing to use the equity you have on your home as a means to accessing capital to invest.
What are the benefits of refinancing for investment?
Refinancing to help you invest is a good way to kick start your property investment journey without needing to save up thousands of dollars for a deposit upfront. The financial strain of saving for a deposit whilst repaying one’s current mortgage is what prevents a lot of individuals from kickstarting their investment journey. If you’re in the position to refinance your home and use it to buy a second property, you could effectively:
- Decrease the time it takes you to buy that first investment.
- Open up areas for cash flow (from rental income).
- Potentially build up more equity from your investment.
- Avoid paying for Lenders Mortgage Insurance (LMI) with your investment.
What ways can I use my current home loan to invest?
There are a few ways you can use your current mortgage to invest. The option you choose will be dependent on your financial situation and how you plan to find your investment.
Accessing equity through loan cash out
One way to utilise your equity for investment is to cash out money through a home equity loan. The process works by getting your home valued and having the bank assess the amount of equity available. After working out the necessary figures, you’ll be able to borrow a certain amount (usually up to 80% of your property’s value) and use it towards investing. Essentially you’ll refinance your home loan at a higher amount than what you previously did, and cash out the remaining balance. This balance will be paid in cash rather than credit and will be available for you to use when you wish.
The main benefit of cashing out your equity through this route is that you’ll most likely be paying off your new loan through fixed repayments. With lower interest rates than other refinancing options and a traditional repayment structure you’ll begin paying off your debt sooner rather than later.
If you’re still in the process of looking for an investment property this could be a downside since you’ll essentially have to pay for a sum of money you haven’t used yet, however having the cashed out equity on standby in case an investment opportunity arises could prove beneficial. You’ll also have the added benefit of not necessarily tying your new investment to your property of residence. Depending on how you have your loans structured, this could remove the risk of having your home repossessed should you default or be unable to service your investment or vice versa.
Accessing equity through a line of credit loan
Another way to use your current property for wealth creation is to apply for a line of credit (LOC) home loan. The amount of equity you have in your home can change the line of credit amount that you’re eligible to borrow or spend; however, put simply, a line of credit loan acts similarly to a credit card that uses your house as security.
You’ll have a set amount available for your use and can draw funds when it suits you for a certain time frame known as the “draw period”. During the draw period, you’ll only have to pay the interest based on the amount you draw or use. Some Line of Credit loans may also require you to make minimum monthly repayments. The draw period will depend on the terms and conditions of your loan, however most commonly goes on for 5-10 years.
After the repayment period you’ll enter the “repayment period” whereby you’ll be required to repay the outstanding amount you’ve borrowed and interest by a certain time. During the repayment period you will no longer be able to draw money without refinancing again.
The main benefit of a LOC loan is that it offers you a certain degree of flexibility and doesn’t require you to pay off debt straight away. Having funds on standby can be useful when you know you want to invest but haven’t yet found the right property and are actively searching the market.
However it is generally harder to be approved for a line of credit loan due to the risk to lenders. Given the flexibility of an LOC loan it can also be easy to forget about debts or splurge on unnecessary luxuries putting you in a potentially damaging financial position. Line of credit loans also have higher variable interest rates than traditional loans, meaning you’ll have to be confident that you’ll be able to service the loan if interest rates rise.
What types of investments can I make?
If you’re planning on taking out a second mortgage and using the equity from your current home for investment purposes it would be beneficial to invest the money in something that usually grows in value over time and can partially service itself, i.e. property investments.
If you’ve done your due diligence and have found a property located in a high demand area, chances of tenant vacancy could be low meaning that part of the rental income can be used to service the new loan.
To ensure you’re investing in a high growth area make sure to research which suburbs and streets are in high demand and have continued to show positive growth over the years. Other factors that could affect growth are if the property is close by to public transport, schools, shopping centres or even hospitals.
Completing your due diligence is essential to making sure that you purchase the right property and that you aren’t required to service both your current mortgage and the investment.
Another investment area to potentially use your equity in is in shares and stocks. However this route brings in another bunch of various factors to take into consideration such as the state of the stock market or whether you’re buying at a low or high. Overall, uses for equity can vary however if you’re looking to make financial returns, investing in property could be a good way to go.
How much can I borrow?
How much you can borrow and release in capital (equity) again depends on the value of your home and how much you owe on your mortgage. To calculate your total equity amount you usually subtract the amount owing on your home loan from your property’s appraised value. However total equity and usable equity are two different amounts with the latter usually being 80% of your home’s current value minus your outstanding loans.
Are there any risks I should know about?
Depending on the way you structure your loans, there is the risk of losing your properties. This will usually occur if you use your residential property as security for your investment loan or your investment. For this reason it is usually advised to keep loans separated.
Another overall risk revolves around having a stable enough income to service both loans if required. One way to get rid of this risk is by hiring a property manager or agent that offers rental guarantees or to ensure you have landlord insurance.
Where to go from here?
Making the decision to refinance for investment purposes is a substantial one, and shouldn’t be taken lightly. However, when done correctly, releasing your equity could be your path to wealth creation and portfolio building. If you’re unsure where to go get started or simply want to know more about the process and if you’re eligible to refinance and release equity speak to us today!