Investing in property is one of the most popular ways to build wealth over time. But many people worry about the large deposit required to buy an investment property. A smart way to overcome this challenge is by using the equity in your existing home.
This blog will explain everything on how to use equity to buy investment property, including clear examples, calculations, and tips to make smart financial decisions.
What is Equity?
Equity is the part of your home that you truly own. It is the difference between the current market value of your property and the amount you owe on your mortgage.
Equity Formula:
Equity = Market Value of Property – Outstanding Mortgage Balance
Example:
If your house is valued at ₹80,00,000 and you owe ₹50,00,000 on your mortgage, your equity is:
₹80,00,000 – ₹50,00,000 = ₹30,00,000
This ₹30,00,000 represents the money you already own in your home, which you may be able to use to invest in another property.
How Much Equity Can You Use?
Lenders usually allow you to borrow up to 80% of your property’s value without requiring Lenders Mortgage Insurance (LMI). This percentage is called the Loan-to-Value Ratio (LVR).
Usable Equity Formula:
Usable Equity = (Property Value × LVR) – Outstanding Loan Balance
Example:
- Property Value: ₹80,00,000
- LVR: 80%
- Outstanding Mortgage: ₹50,00,000
Usable Equity = (₹80,00,000 × 80%) – ₹50,00,000 = ₹64,00,000 – ₹50,00,000 = ₹14,00,000
This ₹14,00,000 can potentially be used as a deposit for an investment property.
Step-by-Step Guide: How to Use Equity to Buy Investment Property
1. Get Your Property Valued
Start by getting a professional valuation of your property. This gives a clear idea of how much equity you have.
2. Calculate Your Equity
Subtract your current loan from your property’s market value to determine your total equity. Then, calculate the usable equity based on your lender’s LVR rules.
3. Understand Lender Policies
Banks may lend up to 80% of your property value. Some may allow more if you pay for LMI. Check with your lender before planning your investment.
4. Plan for Additional Costs
When buying an investment property, consider extra costs:
- Stamp duty
- Legal fees
- Inspection fees
- Maintenance costs
5. Apply for a Loan
You can access your equity by refinancing your existing mortgage or topping up your current loan. Then use that money as a deposit for the investment property.
Example of Using Equity
Suppose:
- Your home is worth ₹80,00,000
- Mortgage balance: ₹50,00,000
- Usable equity: ₹14,00,000
- Desired investment property: ₹60,00,000
You can use ₹14,00,000 as the deposit. The remaining ₹46,00,000 can be financed with a new mortgage. This allows you to own a second property without saving a large deposit.
Benefits of Using Equity
- No Need for a Cash Deposit: You can leverage your home’s value instead of saving thousands of rupees.
- Build Wealth: Investment properties can grow in value over time.
- Rental Income: Generate passive income from tenants.
- Tax Benefits: In some countries, loan interest and expenses on investment properties are tax-deductible.
- Start Early: You can start property investment earlier without waiting to save a deposit.
Risks and Considerations
While using equity can be powerful, it comes with risks:
- More Debt: You are borrowing more money, which increases your financial risk.
- Interest Rate Changes: Rising interest rates can make repayments higher.
- Property Market Fluctuations: The property’s value may decrease, affecting your equity.
- Vacancies: If tenants stop paying or the property is vacant, you must cover repayments.
Tips to Make a Successful Investment
- Research the Market: Choose areas with growth potential and strong rental demand.
- Seek Professional Advice: Consult financial advisors or mortgage brokers.
- Maintain a Reserve Fund: Keep savings for loan repayments, maintenance, or emergencies.
- Choose the Right Loan Type: Interest-only loans may reduce monthly payments but seek advice before choosing.
- Calculate Expected Returns: Consider rental income, expenses, and potential growth.
Calculations: How Much Can You Borrow?
Suppose your home is worth ₹100,00,000 and you owe ₹60,00,000. You want to invest in another property worth ₹70,00,000.
Step 1: Calculate Equity
Equity = 100,00,000 – 60,00,000 = ₹40,00,000
Step 2: Usable Equity (80% LVR)
Usable Equity = (100,00,000 × 80%) – 60,00,000 = 80,00,000 – 60,00,000 = ₹20,00,000
Step 3: Deposit for Investment Property
You can use ₹20,00,000 as a deposit for the ₹70,00,000 property.
Remaining loan required = 70,00,000 – 20,00,000 = ₹50,00,000
Step 4: Check Rental Income and Repayments
If expected rental income is ₹40,000 per month and loan repayments are ₹35,000 per month, the property is cash flow positive.
Common Strategies for Using Equity
- Deposit for a Second Property: Use equity as a deposit to buy another property.
- Renovate Your Home: Increase your property value, which can increase your equity.
- Combine with Savings: Use part of your savings with equity to reduce loan size and risk.
Tax Considerations
- Interest Deductions: Loan interest on investment properties may be tax-deductible.
- Negative Gearing: If rental income is less than loan repayments, the loss may reduce taxable income in some countries.
- Professional Advice: Always consult a tax professional before making decisions.
Also Read: Can I Use My Super to Buy an Investment Property?
Final Thoughts
Using equity to buy an investment property is a powerful way to grow your wealth. By understanding your equity, lender policies, and financial risks, you can make informed investment decisions. Always plan carefully, calculate your repayments, and seek professional advice to minimize risks.
Investing in property with equity can help you achieve financial security, create passive income, and build long-term wealth.
