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Turning theoretical value into real profit

If you own your home, you’re building equity whether you know it or not. If you’re smart, you could use that equity to buy an investment property.

Equity is the difference between the current value of your home and the amount you owe the bank. You build equity by paying down your mortgage – and by the increasing market value of your home. If your home is worth $700,000 and you owe $400,000 on your mortgage, you have $300,000 in equity.

It sounds like a lot of money. But for many people, that value stays trapped in their home until they decide to sell up – so it doesn’t offer much benefit. A home equity loan lets you access your equity without selling. Instead, you use it as the deposit for an investment property.

Increasing value, increasing equity

Put simply, equity is the difference between what you owe on your mortgage and what your home is actually worth.

When you first buy a home, the equity is the value of the deposit – say, $100,000 on a $700,000 mortgage. As you make regular mortgage payments, the loan slowly decreases, and your equity grows. As most home-owners will attest, paying off your mortgage can be painfully slow – so it’s lucky that equity builds in another way as well.

Generally, your house’s value increases the longer you stay in your home. Although housing markets do experience falling prices, New Zealand’s market has been increasing rapidly for several years. Unless you seriously overpay for a property, you’re likely to see an increase in value.

As the value of your home increases, so does the equity. Think about it: if you pay $500,000 for a home, with a deposit of $100,000, your equity is $100,000. Three years later, your home is worth $650,000, an increase of $150,000 – this means your equity is now $250,000. That increase in value is all yours, with very little effort on your part. Of course, if you renovate and remodel your home, you could help increase the value even faster – but this is offset by the cost of renovations.

Putting equity into action

When you sell a property, you release the equity – and most often, use it to buy a bigger or better home. But if you’re happy where you are, a home equity loan lets you make the most of your equity without moving.

Many lenders offer loans based on the equity built up in your current property. Basically, you use the equity as a deposit on the purchase of a second investment property. The more equity you have, the more you’ll be able to borrow – current LVR rules mean you could be allowed to borrow up to 80% of the market value of your home.

Of course, increasing your borrowing always comes with risk – if you borrow heavily against your first property to buy a second, you risk losing both if you can’t make repayments.

Structuring your home equity loan

All home equity loans are not created equal. There are two main ways to structure this type of loan, each with its pros and cons.

With a stand-alone equity loan, the bank releases the equity from your current mortgage and it’s used as the deposit for your second property. This way, you have two separate mortgages for the two separate properties, which can make it easier to manage repayments and rental income. If you end up selling your investment property, it’s usually less complicated with a separate mortgage.

The second option is a cross-collateral loan. With this type of mortgage, you essentially add the investment property to your current mortgage. This means both properties are covered by one mortgage repayment, but it also means both properties are held as collateral for the loan.

Expert advice for a major decision

Buying an investment property is a big decision, and if you’re thinking of leveraging your equity to do so, that makes it even more complicated. Valuing your current property, choosing an appropriate loan structure, and considering the tax implications of a rental property can all be tricky for beginner investors.

That’s why it’s essential to seek expert advice before you start. A mortgage broker or adviser will be able to work out exactly what you can borrow, explain the pros, cons, and possible consequences, and help you find the best deal on a home equity loan.

Ready to unlock the equity in your home? Talk to the expert advisers at Global Finance now. Call us on 09 255 5500