Sound financial decisions require careful consideration and analysis. One such decision is whether to use your home equity to purchase an investment property. While it may seem like a smart move, there are several factors to consider before making such a significant investment.
What is home Equity?
Home equity is the difference between the value of your home and the outstanding mortgage balance. For example, if your home is valued at $1,000,000, and your mortgage balance is $600,000, your home equity is $400,000.
So home equity is essentially the difference between value and debt, but does not represent the amount of lending you can obtain against the property.
Most lenders allow you to borrow up to 80% of the valuer of the property, without the need of paying mortgage insurance. So in the above example, a further $200,000 could be borrowed against the home, taking the total lend against the home to $800,000 or 80% LVR. This $200,000 equity loan could then be used to fund a new investment property purchase.
Using your home equity to purchase an investment property can be a viable option for those looking to diversify their investment portfolio. However, before making this decision, it’s essential to understand the potential risks and rewards.
Benefits of using a home equity
One of the significant benefits of using home equity to purchase an investment property is that you can access significant funds that would otherwise be challenging to obtain. This approach allows you to leverage/borrow the equity you’ve built in your home to make a substantial investment in another property.
This rinse and repeat approach, whereby you borrow more against a property as the value rises to purchase the next property, is the way that many investors are able to accumulate many investment properties and create large amounts of wealth.
Risks of using home equity
However, using your home equity to purchase an investment property is not without risks. One of the most significant risks is that you’re putting your home at risk. If you struggle to meet repayments, in a worst case scenario, you could end up losing both the investment property and your home. It is recommended to “uncross” the properties to mitigate this risk.
Another risk is that you’re taking on additional debt. When you use your home equity to purchase an investment property, you’re essentially taking out a second mortgage. This means that you’ll have two mortgage payments to make each month, which can be challenging to manage if the investment property doesn’t generate enough income.
Factors to consider minimising Risk.
Your financial situation – Before using your home equity to purchase an investment property, it’s important to assess your financial situation. Consider your income, expenses, and debt. Make sure you can comfortably afford the additional mortgage payment and any other expenses associated with owning an investment property, such as property taxes, maintenance, and insurance if the property goes for a period without generating rental income.
The investment property’s potential – It’s crucial to assess the investment property’s potential before making a purchase. Consider the property’s location, rental income potential, and property growth prospects. Make sure the investment property aligns with your financial goals and investment strategy.
Conclusion
In conclusion, using your home equity to purchase an investment property can be a smart financial decision if done correctly. It can provide access to significant funds for investing. However, it’s essential to consider the potential risks and rewards carefully. Do your research, assess your financial situation, and make a well-informed decision that aligns with your investment goals and risk tolerance. Always speak to the experts financial advisers, mortgage property, buyers advocates and accountants.
