Use your home equity to invest in property
A home loan is likely to be the largest debt a client will ever take on. It can make sense to reduce that debt fast especially in the early years where the amount of interest payable is at its highest. The less owing on the home loan, the more equity in the home.
Case study: Sarah and Gary buy a second property
Sarah and Gary are both in their early 40s. They are concerned that while they have been focused on paying off their home loan and meeting other financial obligations, they haven’t been investing other than making some small personal contributions to their super funds.
After talking to their adviser about a range of investment options they decide to buy a $500,000 apartment they are looking at in an area they know.
Sarah and Gary:
- Have $250,000 owing on their home, which is currently valued at $650,000.
- Could potentially borrow an additional $270,000 against their home to go towards buying an investment property.Their adviser discusses some options then recommends they make an appointment with their lender to find out the how they should finance their investment property.
After meeting with their lender Sarah and Gary decide to borrow $540,000 to cover the purchase price of their investment property as well as other costs associated with purchasing property.
Sarah and Gary now have:
- A home valued at $650,000 and an investment property valued at $500,000.
- Total loans of $790,000, or debt at slightly under 70%.
- Rental income from the apartment is $450 per week. After allowing for rental agent fees of 7%, they receive a monthly rental return of $1,814.
- Interest costs on the investment property of $2,678 per month (based on a standard variable interest rate of 5.95% pa). This means Sarah and Gary have to meet a monthly shortfall of $864 to cover interest costs on their loan. This will fluctuate over time as interest rates and rental returns change, but Sarah and Gary are confident that they can manage this shortfall.
Their adviser helps them develop a strategy to pay off their home loan as quickly as they can by directing any extra income such as tax refunds, bonuses and salary increases into their home loan.
Sarah and Gary hope that over time their rental property will generate higher rent and appreciate in capital value.
The case study about Sarah and Gary is a fictitious example to demonstrate the possibilities of using the equity in your property to purchase an investment property and may not be applicable to you.