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Aaron Alston

How to Utilise Your Existing Equity to Purchase an Investment Property

Written by Aaron Alston

Kris Wrenn wrote an article in the July Hudson report on how to calculate the holding costs of an investment property.  In addition to that article, this article will illustrate how to use your existing equity in your home loan to achieve your goal of purchasing an investment property and grow your wealth.

Example 1 – Using the equity in your home to purchase an investment property

Bill and Leanne want to buy an investment property.  They currently owe $100 000 on their $1.2M home and have about $50 000 in savings.  Rather than use their savings, Bill and Leanne decide to engage a mortgage broker to determine how much they can borrow using their equity.  The mortgage broker reviews their financial situation and determines they can borrow up to $900 000.  Bill and Leanne don’t want to borrow this much and decide to apply for $750 000 loan.

They are pre-approved for a $750 000 loan and purchase a residential investment property for $700 000 plus $30 000 purchase costs.  To avoid Lenders Mortgage Insurance, they use the existing equity in their home for a 20% deposit of $150 000 plus $30 000 for costs ($180 000 total).  They then secure the remaining 80% of the loan against the investment property ($600 000 total). The mortgage broker splits the loans, so the loans are secured against the respective properties whilst keeping both properties under an 80% loan to value ratio (LVR).

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Outcome

Bill and Leanne have achieved their goal of purchasing a $750 000 investment property through the power of leverage.  Let’s say the property was in a high-growth area and doubled in value over 10 years.  In 10 years’ time it would be worth $1 500 000.  Bill and Leanne’s initial equity of $150 000 would now be worth $900 000.  I have assumed in the below table that the investment debt hasn’t reduced to purely illustrate the growth.

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Example 2 – After 10 years, using the available equity in investment property 1 further to purchase another investment property

Bill and Leanne decide to access the equity they have accumulated in their 1st investment property to buy another property (and repeat the process again).  To keep things simple, I have assumed they purchase another property for $750 000.  They access their available equity of $150 000 plus $30 000 costs to ensure they don’t pay LMI (see tables 1.5 and 1.6 below).

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Outcome

Bill and Leanne now acquired $2 250 000 of investable assets through the power of leverage.  Let’s assume again that both areas doubled in value over 10 years.  In 10 years’ time investment property 1 would be worth $3 000 000 and investment property 3 worth $1 500 000.  Again, I have assumed that the investment debt hasn’t reduced to purely illustrate the growth (see table 1.7 below).

[table id=23 /]

By now you can see the effect of compound growth over time.  Bill and Leanne have now accumulated a whopping $3 120 000 in equity after 20 years and it all started by taking the first step and using the available equity in their home loan to purchase an investment property.

There are several factors at play when it comes to investing in property which includes: researching and buying an asset that will grow in value (this involves time and diligence), managing your investment expenses and cashflow annually (which Kris Wrenn emphasised in his previous article), spending less than you earn and investing with a focus on the longer term.

THE BENEFITS OF INVESTING V SAVING

If Bill and Leanne never took the first steps to invest and attempted to “save their way” to retirement, they would not accumulate the amount of wealth they achieved v using their equity in their properties.  Even if they saved $50 000 p/a for 20 years they would accumulate $1 000 000 over that time v the above scenarios where they have accumulated a $4 500 000 property portfolio with available equity of $3 120 000.

Say Bill and Leanne decide to sell both investment properties and be debt free when they retire.  They would have a $3 000 000 capital gain because they purchased both properties for $750 000 each ($1 500 000 total).  As they have held both assets for longer than 12 months, they would qualify for a 50% discount (reducing their total capital gain to $1 500 000).  Even if Bill and Leanne were in the highest possible tax bracket, they would pay approx. $700 000 in capital gains tax still leaving them significantly better off ($3 120 000 equity less $700 000 capital gains tax & sell costs) than where they would have been if they merely saved.

Summary

  • Use someone else’s money (the bank) to utilise the power of leveraging with a focus on the long term to achieve greater investment returns.
  • The hardest part of investing is often taking the first step. Make your money work smarter not harder.  Saving your way to retirement is working harder not smarter.
  • I have used property in this example to illustrate the power of compound growth and using equity in your home to create wealth.
  • Hudson can assist you through every step of the process so if you would like to know how to go about what I have explained in this article, please contact us.

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