How do you use the equity in your rental house to buy another?

[Reno]

Hi There.

I was a bit apprehensive about asking this as it is either a simple question or it has been asked before (I have searched but cannot find the answer easily)

We have about $80000 in equity in our current rental. We want to use that equity. We realise the bank will not lend all of it. So if we want to use $40000 for further investment...

What are the options now?
I can come up with the following but not sure if it is correct or what is best.
Do we borrow 100% for the new property with the current IP as security? Or.
Do we loan the $40 000 from the bank which will increase the mortgage of the existing property. Then use it to buy further.
An option that we're not keen on at the mo is selling
What else can you do?
Any advice will be welcome


Cheers

[NESW]

Why not obtain a new valuation to present to the bank with your loan application?

[Lynda]

A mortgage broker will be able to answer this better (monkeyboy?), but here goes:

Probably the best way to access the equity in your current property is to arrange a revolving credit facility (RCF) with your current bank up to whatever they will give you. A new valuation will probably be the best way of getting the maximum amount.

When you use a RCF, you only pay interest on the outstanding balance, not on the maximum amount you can borrow.

You then use this facility to pay the deposit on your new purchase. When you get your finance for the new property, try as hard as you can to avoid the bank cross-collateralising the two properties. That means having one secured against the other. At settlement you use the RCF to make up any difference (if there is one) between your deposit plus the new loan vs the full purchase price of the property.

Here's a for instance:

New property for which you are paying $200,000...
$10,000 deposit paid at unconditional from your RCF;
arrange a mortgage for the new property at 80% of purchase price - $160,000;
Pay the outstanding $30,000 on settlement out of your RCF.
Have a glass of bubbly!

You definitely don't need to sell!

Happy buying.

Cheers,
Lynda.

[revdev]

Hi Reno,

There is a great article about leverage and equity on Kierans website here - http://www.hybridgroup.co.nz/MarketI...il.aspx?id=266 (you will need to download the .pdf file)

I found it very helpful in getting my head around leverage lock - I realise this is a few deals away for you but hey, start as you mean to carry on!

All the best
G

[NESW]

But (from my experience) if you are using borrowed equity from one property to purchase another, then you cannot avoid the financier using both properties to secure their mortgages....

[Monkeyboy]

Top answer Lynda.
Great article of Kierans
Pretty much covers it.
Depending on the lender you are with you may be able to get a RCF up to 90% of the value of the property. You also have to prove serviceability, so you do need to improve your cashflow. Speak to a good broker and tell him your goals and they can help you achieve this with regards to the financing side of things. It does come down to juggling at times.

A simple solution is to purchase the new property and just add it to the portfolio with the same bank. It comes down to the overall Loan to Value Ratio (LVR) of your portfolio with the one lender. With your first few props it may be better staying with the one lender. This gives you greater power in your initial days of PI. It may well be cross-securitised as this gives the lender greater comfort, again fine in early days. Lumping them together will allow you to borrow up to 95% with most lenders, given serviceability is there.

This is but an overview. A good investment minded broker will provide you with the right tools (knowledge) for financing.

[Ivanhoe]

Thanks Michael!
you said:

You also have to prove serviceability, so you do need to improve your cashflow

can you clarify this bit - I think everyone can work out Loan to Value Ratio but I have not seen any example of working out servicability here.
Is there any universal way of checking if any property is "servicability neutral" (notice that I'm not using "cashflow neutral") from major banks' point of view?
thanks in advance!

[Monkeyboy]

Serviceability
Essentially most lenders require you to have an uncommited monthly income (UMI). Most people purchase property equivalent to what they can afford and generally pretty close to maxing out their UMI. Now when you purchase an IP you generally are only allowed to utilise 75% of the rental income in your serviceability. This usually reduces a persons UMI.

So to answer your question so long as 75% of the rent covers the mortgage you will satisfy the lender.
This is possibly hard to do in todays environment and therefore improving cashflow is one method.

Also when calculating mortgage repayments for serviceabilty calculator it is always P & I at 2yrs plus 1% regardless of whether you are on IO or P&I. Each lender uses it's own formulas so they come up with different answers. It also depends on the product you use. So no there is no universal rule but the above is a guideline to most major banks.

[Ivanhoe]

Thanks Michael.
So assuming we are investing in RE rather than using RE as a saving scheme - so our UMI is insignificant compared to rental income let's look at some numbers (correct me if I wrong)
If we buy something for $200,000 we will need the following rents to satisfy servicability:
Scenario A: 30 years P&I, stress loading 1%, weekly mortgage payments $376.92 (that's 75%) so rent should be $502.56 to be "servicability neutral" from banks point of view (actually 13% yield)
Scenario A: 25 years P&I (somehow I think banks would not use 30 years loans when checking payments), stress loading 1%, weekly mortgage payments $392.51 (that's 75%) so rent should be $523.34 to be "servicability neutral" from banks point of view (actually 13.6% yield)
Does it look right?

[tillerman]

Hi NESW

... But (from my experience) if you are using borrowed equity from one property to purchase another, then you cannot avoid the financier using both properties to secure their mortgages....

You simply tell them you do not want to cross-collateralise, if they won't give you the loan go somewhere else.

[Monkeyboy]

Sounds correct Ivan.
Except lenders will use 30yrs in their calculations as this term has become the norm in the NZ Market. In fact if you look at the 50yr mortgage which may become popular in time, the bank may look at using this for their calculations, if that is the loan you have. It was correct in the past to use 25yr calculations, but now if you have a 30 yr mortgage then you can use this calc. But yes some lenders will use the 25yr calc.

[Scott Miller]

Hi Ivan,
Mike's explanation is correct.
When applying for a new home loan the bank will allow you to add all your existing rental income and then apply 75% of that figure as weekly income towards your serviceability.
This, in the banks mind is to allow for vacant possession, bad rental payers etc.
Serviceability is usually calculated over a 30 year period unless the loan is 100% or more, then a serviceability period of 20 years is used.As the bank has no equity to fall back on if everything goes wrong, so they REALLY want to know that you can service the loan, so they make it as hard as possible to fit their preconceived tick boxes.

[Ivanhoe]

When applying for a new home loan the bank will allow you to add all your existing rental income and then apply 75% of that figure as weekly income towards your serviceability.

home="investment property" here, right?

What about "stress loading" which will be similar to reducing loan term - I saw up to 2% also heard about banks using current floating rate, P&I?

What happens if your property is not exactly yielding 13%? Will mainstream banks "tweak" their boxes to make you "fit", offer you to go lo-doc (sometimes it just means a fee but interest rate is the same) or will say "NO"? (provided we are talking LVR 80% or below)

[Ivanhoe]

the loan is 100% or more, then a serviceability period of 20 years is used.

Very exciting! Are we talking about 1% stress loading or more for 100% loans? Also Could you tell if anything else is different too - is ALL 100% of a 100% mortgage on a same fixed rate or is it split somehow? Also I guess 100% mortgage will attract LMI fee - are there any other fees on top of that?

[Scott Miller]

Stress loading is only for serviceability it's not what you are actually charged!!!