Camp Hill resident, George asks
“I own my own home and have substantial equity in it. Do I need a cash deposit to purchase an investment property, or can I use the equity I already have?
Thank you so much”
Great question George.
It is a bit of misconception that you need cash savings to buy an investment property. If you have sufficient equity in your property, you may not need cash savings for a deposit. Here’s some advice to get you started in the right direction.
How this is calculated in it’s simplicity, is that the value of your property is multiplied by 80% then the current mortgage balance deducted from that 80% calculated amount. The difference is the amount that you could draw on to use as a deposit.
For example, you own a property valued at $500,000, you can borrow up to 80% of that value without incurring mortgage insurance. So, 80% is $400,000 and let’s just say you only owed $200,000 on your mortgage, that means $400,000 less $200,000, is $200,000 equity available that you can draw on as a deposit. This means you would not require a cash deposit or savings, the equity in your home is acceptable.
You would still need to have proof of sufficient and consistent income to qualify for that loan plus the new investment loan, you just would not be expected to reflect cash savings in an account.
Lenders will assess your capacity to pay off both loans in the event one property remains temporarily vacant. Whether you are self-employed or have a PAYG position, the lender will consider potential rental income as part of the qualifying criteria. Generally, lenders will accept or consider up to 80% of the potential rental income so when they determine how much you can borrow, they’ll look at your current income plus the future rental income.
It is not necessary to demonstrate to the lender that you are capable of making the repayments without that rental income as lenders only consider 80% of that potential rental income to factor in 20% potential vacancies. When buying an investment property that you’re financing by means of a deposit derived from the equity in your home, it is wise to borrow extra as reserve funds to cover any period of unexpected vacancy.
What about the purpose and usage of the investment property?
Does this impact the likelihood of loan approval if the property remains vacant to renovate?
If you’re buying commercial property, this falls under commercial lending criteria and not under residential property loans. It does not matter if the property stands vacant to renovate the key is that it is for investment purposes. The lender will still consider potential rental income because the intention is to rent it out. Again, contingency funds need to be allocated if the intention is to have the property vacant due to renovations.
If you are looking to draw down from the equity in your home to purchase an investment property it is recommended that you avoid cross-collateralization. This is where you may have equity in your current property and borrow 100, 105% or 110% of the purchase price of the new investment property in one loan. This large single loan is then secured by not only the property being purchased but also the current property. Essentially this ties the two properties together which is best avoided.
The most suitable loan structure is to apply for two separate loans. One loan secured only by the new property being purchased and a second loan which is for the deposit and costs which is only secured by the existing property. Having each loan independent makes it easier to sell or refinance in the future. If the properties are considered as a single transaction they are subject to property value fluctuations jointly.
There are two trains of thought when you draw down equity on an existing property to fund a deposit and costs. The first is that some may like to try and raise a 20% deposit to avoid paying mortgage insurance on the new property. The second is that some people prefer to finance the maximum amount so only 10% deposit, to remain flexible and equity-free in case they want to invest in another property at a later stage. You need to evaluate what best suits your current financial situation and potential future needs.
Have more questions?
For more than 17 years Mortgage World Australia has helped hundreds of Australians realise their dream of owning their own home. Through our affiliation with the largest network of individual mortgage brokers in Australia we can help you find the right loan to suit your needs. Whether you are a first home buyer just starting out on your real estate journey, an experienced investor or you are just looking to get a better deal on your current home loan then give us a call.
Patrick is a Director and a Home Loan Specialist. He has been helping Australians with home loans since 2001. Prior to working as a mortgage broker Patrick was employed by Macquarie Bank for 3 years and also worked as an accountant for a publicly listed company. Patrick holds a Bachelor of Business majoring in Accounting and sub-majoring in Finance and Marketing from University of Technology, Sydney.