You’ve purchased your first home and you’re reluctant to expand your property portfolio because of how long it took you to save up the initial deposit. What if I told you that you could purchase a new property without using any of your holiday savings as a deposit?
Buying a second property has the same requirement of a 20% deposit to avoid Lenders Mortgage Insurance (LMI). However, instead of using cash savings you could use the equity in your current property as the deposit. How does this work:
Lender’s will let you borrow up to 80% of the first property’s value so in the above example you could borrow $600,000 (80% of $750,000). As you have an existing loan of $500,000, this means the amount of equity you can use for a deposit is $100,000 ($600,000 – $500,000). Now you’ve established how much equity you have in the property it’s important to understand just how you can use it.
Let’s use the above example where you’ve got $100,000 equity in your existing property and let’s assume you’re looking to buy an investment property for $450,000 (a 20% deposit is $90,000):
Cross-Collateralisation
The most common method when using equity to purchase an investment property is cross-collateralisation. This option uses the existing property as collateral and adds it to the new investment property loan to help with the purchase. This results in two loans:
1. Original home loan secured against the original property
2. New home loan secured by existing property and investment property
Therefore, your structure would look like:
Home Loan Top Up
An option to borrow against the equity in your current property is to get a home loan top up on your existing home loan. The top up amount is paid into your account, and you can use these funds as the deposit for the new investment property. For example:
Therefore, your structure would look like:
Therefore, you would increase your existing loan by $90,000 and use those funds to purchase the investment property worth $450,000. This would leave you with $10,000 equity in your original property ($100,000 – $90,000). This option is dependent on lender policy.
It’s recommended to discuss the best structure for the investment property with an accountant before signing on the dotted line. There will also be extra ongoing costs involved with purchasing an investment property such as council rates, insurances, maintenance, property management fees, etc.
Building on your Property Portfolio can be an overwhelming process, but it doesn’t have to be. If you have any questions or would like to discuss a scenario, please contact me on 0401 225 713 or lmckean@lbkprivatelending.com.au.
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