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Equity - how does it work???

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  • Equity - how does it work???

    Hi guys,
    second thread in only a few days . . . hope I'm not overstepping the mark!

    Just wanted to ask a question about equity. I have tried several searches on this site, but just about everything BUT the right answers are appearing!

    Probably like most home-owners, I understand what it is, but have no idea how to use in when purchasing another property!

    So I'd like to ask if someone could go through the steps for exactly "HOW" I can use my own home equity to help purchase another investment property (don't have the first one yet but I'm working on it!) . . . . . . and how it all fits together with the bank?

    Thanks,
    Steve
    Your attitude, not your aptitude, will determine your altitude. (Zig Ziglar)

  • #2
    second thread in only a few days
    Absolutely not - its fantastic that you are happy to put up your hand and say 'HELP!'.

    As for equity, an example is probably the easiest way to demonstrate it.

    Lets say you have a house worth $400,000 with a mortgage of $200,000 on it - i.e. $200,000 of 'equity'.

    When you purchase an investment property, a typical bank lender will be happy to provide 80% of the purchase price. Lets say you want to buy one for $300,000 - the bank will lend you $240,000 (80% of $300,000).

    This leaves you with a bill of $60,000.

    A-ha! Not a problem - you've got $200,000 equity in your home. The question is how to get at it.

    In this case, true, it shouldn't be a problem. If we look at the combined value or you new property empire:

    Value : $400,000 + $300,000 = $700,000

    and the debt that will be owing on it:

    Mortgages: $200,000 + $240,000 = $440,000

    Now, the magic figure here is your overall 'Loan to Value Ratio' (LVR)

    $440,000 / $700,000 = 62.8%

    So long as that overall ratio stays below 80%, the bank will be happy.

    If we look at the ratio with the bank lending all $300,000 for the investment:

    ($200,000 + $300,000) / $700,000 = 71.4%

    Still OK - you've found the $60,000, and can go ahead and purchase.

    However - there is always a however - to do this, the bank will want to 'cross-collateralise' the properties - this means that your new mortgage (now for $300,000) will have the investment property AND your PPOR (principle place of residence) listed as security.

    In a worst case scenario (investment burns down, insurance won't cover it), the bank can force the sale of your PPOR to pay off the mortgage on the investment.

    The other thing that the bank will be interested in is your ability to repay the $300,000 loan (known as servicability) - some of it will be covered by rent, but the rest will be coming from your normal day job, so they'll want to know about that too.

    Hopefully this has given you enough to chew over - as with most topics, there is always more. As a clue, search for 'revolving credit' or 'Line of Credit (LOC)'.

    If the answer doesn't reveal itself - ask another question!

    Good luck

    cube
    DFTBA

    Comment


    • #3
      Cube,

      Fantasmagorical answer - yes I see it now . . . like most things, it's easy when you know how it's done!

      Thanks sooooo much!

      OK, back to work - just found an excellent post for newbies by Monid:

      propertytalk.com/forum/showthread.php?t=8374

      I'm going through it post by post, should take me a while, but already I've found some useful information. Still a bit "nervous" about that first IP, and not 100% sure what kind of structure I want to aim for (guess that'll change in the future - whatever I decide now), but there's no time like the present for getting myself educated.

      Thanks again . . . look forward to reporting back at some stage soon!

      Cheers,
      Steve
      Your attitude, not your aptitude, will determine your altitude. (Zig Ziglar)

      Comment


      • #4
        not 100% sure what kind of structure I want to aim for
        Hi Steevg welcome to the forum.
        I would recommend to get a structure advice from your solicitor or accountant before you purchase your first property. to prevent tax complication in the future.
        It might cost you $500-$2000 to sett your structure up but it is well worth it.

        Good luck
        Hadar
        Last edited by Orkibi; 18-11-2007, 10:17 PM.
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        • #5
          Thanks for the advice,

          Can anyone recommend either an Accountant or Lawyer in town who's particularly good in these area's of expertise?
          Your attitude, not your aptitude, will determine your altitude. (Zig Ziglar)

          Comment


          • #6
            Send a PM to Fritz and ask him.
            "There's one way to find out if a man is honest-ask him. If he says 'yes,' you know he is a crook." Groucho Marx

            Comment


            • #7
              And do a two bank deal ...

              One way to limit your exposure under a cross collateralisation is to use a two bank strategy.

              Basically you borrow 80% from bank 2 on property 2, the IP, and raise the other 20% against your own home, property 1, from bank 1.

              You might use a guarantee to do this.

              Throw in an LAQC and a trust and you may just have limited yourself to a 20% (plus two years interest and charges depending on bank's the documentation) exposure on the downside of the IP.

              In some professions advice like that can pass for real work! Not bad!

              Comment


              • #8
                You can often borrow 90% for your first one or two investment properties and restrict your borrowings against your own home to 10%. Even better, buy the investment at 10% or better under market value and in 6 months time, get it revalued and refinance so that you have no money from your own home (adding value to the property is another way of achieving this).

                John

                Comment


                • #9
                  Originally posted by steevg View Post
                  Probably like most home-owners, I understand what it is, but have no idea how to use in when purchasing another property!

                  Well im not a home owner yet. But maybe thats why i dont understand the concept of equity at all. Would anyone care to explain? Thanks Jason

                  Comment


                  • #10
                    Equity is a non-cash item which represents your wealth in property. If your house is worth $200K and your loan is only $100K then you have $100K in equity. This belongs to you and if you sell you house you should end up with $100K in the bank (less agents and lawyers fees etc).

                    John

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                    • #11
                      thanks for that. I should have just read the 2nd post, it explains it all. Cheers

                      Comment


                      • #12
                        Equity is your net worth ,if you have 100k in the bank it is your equity, if you take 50k of the 100k to place as a deposit on a property that 50k is your equity in that property ( you did not borrow it , it is yours debt free.)

                        now , if you buy a 200k property with 50k deposit and after 2 yers the property is worth 250k so your equity is the deposit 50k + new extra 50k on property value and 50k in the bank = 150k Equity.

                        hope it help
                        H
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                        • #13
                          So if I go to the bank and show them a re-valuation of my property, how is the equity released to me, and how is this "loan" paid back?

                          Ta,
                          Steve
                          Your attitude, not your aptitude, will determine your altitude. (Zig Ziglar)

                          Comment


                          • #14
                            lets say you purchase a property for 200k with 20% deposit of 40k and you borrow the rest 80%- 160k.

                            after two years the property value is 250k , so you refinance or top up the mortgage for 80% from new value of 250k = 200k . this is 40k more that the bank will lend you (the top up).

                            you will have bigger lone now of 200k, more cost of interest to pay.
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