August 1, 2018
Thinking of refinancing to invest in property and grow your wealth? If you have a lot of equity built up in your home, you could be sitting on untapped potential for wealth building.
Here’s the thing. If you can find a good investment property, you could enjoy a healthy return and help to secure a more comfortable financial future. You’ll be able to add a rental income to your current income. Once you pay off your mortgage, you’ll be looking at an even greater return as you’ll only have to worry about management and ownership costs.
Over the ten-year period from 2006 to the end of 2016, the average annual return for a residential investment property in Australia was 8.1%, as reported in the ASX/Russell Investments 2017 Long-term Investing Report. That’s an attractive option – for those who are in a strong position to refinance to buy a second property. There are a few factors you should look at to help you decide if you are ready to make this financial move.
The first question you need to ask is if you have enough equity to refinance your home loan to invest. If you purchased your home a few years ago, you may have plenty. And not necessarily because you’ve paid down your mortgage that much.
Home equity is the difference between the current market value of your home and the balance due on your loan. So, when your home value goes up, and when your loan balance goes down, your equity increases.
What has happened for many homeowners who purchased before or during the Australian housing boom is that the market value has gone up – for some individuals, it’s gone up a lot.
From 2016 to 2017, the median home price increase across the eight capital cities was 14.1%! And that’s just a one-year increase.
How much equity do you need to refinance to buy an investment property? You’ll want to have at least 20% of the value of the second property available for your new loan to avoid paying lender’s mortgage insurance (LMI). When figuring out how much equity you can use, keep in mind, banks generally will only let you use a loan to value ratio of 80% or lower. This is known as your usable equity. It is equivalent to 80% of your property value, minus the amount you still owe on your loan. Some lenders will let you refinance to buy an investment property with up to 90% loan to value ratio (LVR). While you’d have more money to invest with so you could purchase a more expensive property, you’d need to weigh the increased expense of paying LMI against the benefit of getting a more expensive investment property.
So, for example, if you purchased your home for $420,000 a few years ago, but it is now valued at $500,000 in today’s market and you still have a mortgage of $200,000, you’d have $300,000 in home equity ($500,000 – $200,000 = $300,000). However, you’ll want to calculate your useable equity instead. So, based on the above example:
- Your home’s value x 0.80% = $400,000
- The amount of outstanding loans: $200,000
- Your home’s potential useable equity: $400,000 $200,000 = $200,000
Looking at the above calculation, you would have $200,000 of useable equity. You could then refinance your existing home loan to unlock that equity and purchase another property. Then, you can use the rental income to help you pay down your new loan.
There are in fact, a few costs involved, in addition to the potential for LMI when you are purchasing a second property for investment purposes. Make sure you keep them in mind when deciding what you can afford.
Costs of Purchasing Your Investment Property
- Refinancing costs such as the application fee and any discharge fees
- Stamp duty
- Conveyancing fees
- Legal fees
- Pest and building reports
Costs of Owning Your Investment Property
- Insurance costs
- Property management fees, if you are using these services
- Land tax
- Council and water rates
- Maintenance and repair costs
Another consideration before refinancing to invest in property is risk. As with any type of investment, an investment property does come with some risk, as there is no guarantee you will get the return that you expected.
First, both the property market and the rental market play a role in how lucrative your property investment turns out to be. When the property market hits a downturn, your rental’s value could decrease. Just as rising values help property owners gain equity, decreasing value means your equity goes down. This could put you in a tough spot if you need to unlock your equity in the future.
If the rental market in your area runs into trouble – for example, fewer people are renting because they’re buying, there are fewer jobs in the area, or there is an increase of competition for tenants – you may also run into financial trouble. You could have to lower your rent in order to attract tenants. You also may end up with periods of time where you don’t have any tenants – which means no one’s paying rent. You’ll then have to pay your mortgage payments without the help of your rental income.
Bad tenants could also end up costing you more than you had anticipated. Late rent payments and unannounced vacancies could leave you having to scramble to stay on top of your financial obligations and having to find new tenants.
It’s important to factor in all these risks. Do you have plenty of money saved and a high enough income to deal with untenanted periods? Have you budgeted for upkeep and maintenance costs, as well as for professional services such as management, accounting, and legal fees to ensure you have everything in order for your investment property?
The fact is, there are costs and risks involved. There’s also a great potential for financial growth and security. In order to make the smartest moves when you refinance, make sure you get professional help. Talk to a financial advisor to help assess your financial situation and plan. Use a mortgage specialist or mortgage broker to help you find the right loan when you refinance.
As long as you have the equity, understand your risks, and have a plan in place to refinance and cope with market changes, you have the potential to join the ranks of Australia’s residential investment property owners. Who knows – you may find you have a knack for investing and use your built-up equity to refinance and purchase a second investment property down the road!
Written by Refinancing.com.au
Refinancing.com.au is an end-to-end service that helps people refinance their home loan. We empower you to search for your home loan, and choose the process that suits you.
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