Unlocking the potential from your own home. How to leverage your equity to buy an investment property

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1 Unlocking the potential from your own home How to leverage your equity to buy an investment property Presented by Momentum Wealth Momentum Wealth IP Pty Ltd 2014

2 Contents What makes your home so special? How much is your home worth? How much will a bank lend you on the equity in your home? Having a plan Choosing a lender Where to go for help

3 What makes your home so special? For generations it has been the great Australian dream to own your own home. Despite the difficulties of saving for a deposit, securing a loan, then finding a property that suits you, it remains an aspiration of most young people. The reasons are mainly around security. You feel that if you own your own home even though you have mortgage repayments to meet each month you are more secure than renting off a landlord who may put the rent up, not renew your lease, or sell the property from under you. With your own home, you can decorate it, renovate, do whatever you like with it (within reason!). Those are the psychological reasons for buying your own home. The financial reasons are just as compelling, if not more so. Your home is a valuable asset Firstly, your own home is an asset that usually increases in value over time. Your grandparents or parents will readily tell you of their experiences where they paid $20,000 for the family home 30 years ago that is now worth more than $500,000 (or similar). Over time almost all property will increase in value often considerably and at the same time it provides you with somewhere to live! Your home is capital gains tax-free Secondly, your own home (sometimes called your Principal Place of Residence or PPOR) is the only asset that is not subject to capital gains tax. Going back to the example of your parents and grandparents, if they decided to sell the family home, the profit (i.e. the sale price of $500,000 less the cost price of $20,000 = $480,000) would be theirs and only theirs, nothing goes to the tax office. Amazing! Almost any other assets e.g. shares, investment property, even interest on money in the bank, is subject to tax in some shape or form. You can build equity in your own home Thirdly, if you have been paying off your mortgage for a few years now, you may have equity in your home that you can use to invest. What is equity? Put simply, equity in your own home is the difference between the value of the property if you sold it and the money still owing on your home loan: E.g. property value: $500,000 loan remaining: $240,000 = equity: $260,000 Note this is different to lending equity which is the amount the bank will lend against the property, which we explain further. 3 Unlocking the Potential from Your Own Home

4 The power of Leverage If you are reading this, you are probably considering investing in property to increase your financial security. You like the idea of buying an investment property and having tenants pay off the mortgage while it increases in value over the years. And who wouldn t? The challenge is often coming up with the deposit. Banks will lend you money to invest in property, but rarely for 100% of its value and there are add-on costs to cover as well. Where can you find this money? Remember, the third point above? You could cover the deposit for an investment property using the equity that you have built up in your own home. This strategy is often referred to as leverage. You can leverage off the equity in your own home to invest in other assets. Does this mean that you have to sell your home? No, it definitely does not. You can stay in your own home and it will usually continue to increase in value. Furthermore, you won t have any of the selling costs and expenses associated with buying a new home (such as stamp duty and moving costs, which can be quite considerable). If you have enough equity, even if you still have a home loan you can borrow to buy an investment property! To access the money to purchase a property you will need to re-finance. What is refinancing? Refinancing involves your mortgage broker approaching a lender (which may or may not be your current lender) to increase the money the lender is prepared to lend you, now that the loan is secured by an asset (your home) that has increased in value since you took out the original loan. Unlocking the Potential from Your Own Home 4

5 How much is your home worth? To work out how much your home is worth it will need to be valued. This is not something you need to arrange yourself (unless you really want to). The lender who your mortgage broker approached for a mortgage will arrange to have a valuation done for you. However, if you are considering unlocking the equity in your own home to invest in property, you ll probably want to do some back-of-the-envelope calculations to find out how much it is worth now and how much you might be able to borrow if you refinance. So, hop onto the various websites that list property for sale and have a look at properties of a similar type to yours in your area, and find out what they sold for. You will soon start to get a feel for what your home is worth. A good mortgage broker should also have access to information to help you. Let s assume you paid $300,000 for it 10 years ago and you discover that if you sold it tomorrow it would sell for $500,000. Happy days! But you re not going to sell it, remember? You like living there, you don t want to incur transaction costs and pay stamp duty on your next home, so you ve decided to refinance. Here s the catch, though. Just because your home could be worth $200,000 more today than you paid for it, doesn t mean that a lender will let you take out a loan for $200,000 to invest in further properties. 5 Unlocking the Potential from Your Own Home

6 How much will a bank lend you on the equity in your home? We saw earlier the simple formula for calculating the equity in your own home, but let s now consider how the lenders will look at it. First of all, they will arrange for a valuation and come up with figure, usually on the conservative side. Let s say they agree with your research and arrive at a figure of $500,000. From this amount, they then take what you still owe on your original home loan. You originally borrowed $250,000 and have worked hard to pay off your loan quicker than you had to, and so now you owe $240,000. The difference between these two amounts is: $500,000 - $240,000 = $260,000. So is that what the bank will lend you? Unfortunately not. They will lend you 80% of this total value of the property, without charging you Lender s Mortgage Insurance (LMI), which is $400,000, less the existing debt of $240,000, that leaves $160,000. If you wish to borrow 90% and pay LMI, they will lend you $450,000, less $240,000, which is $210,000. Remember, banks will lend you 80% of the value of the property, according to their valuation. This is not to be confused with the price it is on the market for, or the price you actually pay for the property. If you pay more than the bank s valuation amount, then you are still only able to borrow 80% of the lesser amount without taking out LMI. Loan to valuation ratio (LVR) Lender s Mortgage Insurance Lender s mortgage insurance (or LMI) is an insurance policy that YOU pay if you take out a loan for more than 80% of the amount the property has been valued at. But the insurance payout is to the BANK if you default on your loan repayments and the bank has to take steps to recoup its money. The bank can then sell the property and the insurance covers it for any shortfall between the price they get for the sale and the amount you still owe them. LMI is around 1-3% of the value of the loan and this increases the higher your loan to valuation ratio (LVR) is. So that s approximately $3,500 to $10,500 on a loan of $350,000. You can usually add this amount to the loan and if the borrowings are for investment purposes then you can deduct the LMI paid over five years as a tax deduction. 6 Unlocking the Potential from Your Own Home

7 To avoid paying lender s mortgage insurance you need to maintain an LVR of 80%. This is simply the ratio of how much you borrow to the value of the property. So an LVR of 80% means that you are borrowing 80% of the value of the property (plus costs) and you have funded the remaining 20% with your deposit. If the LVR is 95% (the maximum most lenders will lend) then you have contributed only 5% of the value of the property plus costs and the bank has loaned you 95%. Going back to our example, if you have $260,000 equity in your home and your aim is to leverage off this to put down a deposit on an investment property, then maintaining an LVR of 80%, the bank will lend you $160,000. This should cover a 20% deposit on an investment property, depending, of course, on how much you pay for the investment property. Your mortgage broker would then source another loan for the remaining balance of the purchase price. A 20% deposit on an investment property valued at $500,000 is $100,000, which you can comfortably afford from equity, even with costs for stamp duty, loan application fees, settlement fees, buyer s agent fees and valuation fees to refinance. You will then take out a new loan, with the investment property as security, and the tenants helping you pay off this loan. Unlocking the Potential from Your Own Home 7

8 Having a plan You wouldn t dream of starting out on a hike without a map or some idea of how long the hike will take you. You need to prepare for your hike so that you can take adequate food and water and camping gear if it will be more than a day s hike. In the same way, you shouldn t consider refinancing and investing in property without a plan and a destination in mind. It s a well-worn phrase but there s truth in the old adage, If you fail to plan, you plan to fail. When planning to leverage off your home to start investing in other property, things that you need to consider include: 1. How many investment properties you want to buy 2. What your investment timeframe is 3. Whether you are looking to buy for capital gain or cash flow or both 4. How you will service the loan repayments. Some investors will buy one property at a time and play it quite safe. Others will be surprised at how much equity they are able to unlock from their home and might plan a more aggressive property investing strategy. Either way, it is a good idea to seek support at the beginning of your investment journey. Mistakes you make at the outset can be costly to rectify at a later date. At Momentum Wealth www. momentumwealth.com.au we will help you with your investment planning. We offer property investment and financial expertise to help you build wealth. What is your investment timeframe? This will depend to a great extent on your age and other responsibilities. In theory, the earlier you can start investing the better. But in practice, life gets in the way. Home owners may begin by making extra repayments on their home loan and build up some equity early on. Then perhaps interest rates go up, they start a family and have greater living and childrelated expenses, perhaps one of the couple leaves the workforce for a period to care for the children. They are then not looking to unlock the equity in their own home until they are in their forties. If they plan on retiring in their sixties, then that is a 20-year timeframe to work on their financial security. The sooner you start the better! While it is never too late to start investing, the sooner you start the sooner you can achieve your financial goals. Let s assume you want to achieve financial independence by the age of 60. If you purchased one property at the age of 30 for $500,000 that returned 8% per annum, it would be worth around $5,031,328 at aged 60. If you waited until you were 40, then that property would be worth $2,330,478 at age 60. If you waited until you were 50, then at age 60 that property would be worth $1,079,462. Simply by starting sooner you can build more wealth. 8 Unlocking the Potential from Your Own Home

9 Are you looking to buy for capital gain or cash flow? When you start to plan your property investment you should consider whether the property you purchase will return a positive, negative or neutral cash flow, or whether it will have the potential for strong capital gains. Let s look at cash flow here first. Positive cash flow properties: income from the property is greater than the investor s loan repayments and all other costs associated with holding the property. Negative cash flow properties: there is a shortfall between income from the property and all costs associated with holding the property so the property costs the investor money to hold. Neutral cash flow properties: income from the property is equal to all costs associated with holding the property. There are pros and cons with all these cash flow outcomes. If you find a positive cash flow property it might be at the expense of later capital growth. A property with good growth potential may start off being cash flow neutral or negative but the capital gain will far outweigh this in the long run. Each option, though, will add further equity and increase your capacity to borrow and invest more over time. For example, if the rental income from your property is greater than your outgoings on the property (the loan and related holding costs of the property) then this extra income can pay down your home loan faster and once again start to increase your equity. If your property is more of a growth property, you can have it re-valued and re-financed in a few years time and use the increase in equity in the investment property to continue to invest further. There are many strategies and approaches and it really does pay to consider these with a professional who can explain them all to you. The team at Momentum Wealth can develop a strategy for you. How you will service the loan repayments? When you put your initial plan together, you need to consider how you will repay your loan. Even with a great deal of equity in your home, you still need to be able to meet the interest repayments on a loan. This is referred to as serviceability of a loan. Unlocking the Potential from Your Own Home 9

10 Choosing a mortgage broker When you make the decision to unlock the equity in your own home, it is a wise decision to speak to a mortgage broker. There is no doubt that they will be better educated on the options out there in the marketplace than you are, and they will be able to source the best loan for you and your circumstances. The first thing a mortgage broker will do is work out how much you can afford to borrow. They do this by asking you what you earn, what you owe and what you spend. Loan options available They will then discuss with you the options available. For example, whether a principal and interest (P&I) loan or interest-only loan is most suitable. A P&I loan is where you pay down the original amount you borrowed, together with the interest on the loan. An interest-only loan is where you pay the interest but the loan amount doesn t reduce. You may have a P&I loan for your home loan or use an offset account. This is because your home loan is not tax-deductible. Costs associated with investment loans are taxdeductible, so there is no real reason to pay these loans down in a hurry, unless you no longer have a home loan, so in these circumstances an interest-only loan may be best. A mortgage broker will guide you through the wide range of loan types, some of which our outlined below. Honeymoon rate loans where you get a lower interest rate during the first few months or years of the loan but later pay a higher rate. Line of credit loans where you have the option to draw funds for investment purposes as and when you need them and only pay interest on the amount you redraw, not the whole loan facility. Fixed rate loans where you agree to pay interest at a rate fixed by the bank for a defined period. This gives you peace of mind should interest rates start to rise. Variable rate loans where you pay interest according to the bank s variable rate. We ve only just scratched the surface of the range of loans here. If you add to the types of loans, the different lenders and their terms and conditions, then you start to see the value of professional advice when you re making these choices. 10 Unlocking the Potential from Your Own Home

11 Where to go for help The good news is that you don t have to remember all the information in this e-book, or manage the process of unlocking the equity in your home, yourself. A smart investor will seek professional help to guide and support them. At Momentum Wealth we can help you with sourcing finance, putting together your property plan, finding investment property and even managing the property for you. Visit our website: us at info@momentumwealth.com.au or call for further information. Momentum Wealth IP Pty Ltd 2014 used under license by Momentum Wealth Education Pty Ltd. Unit 2, 1 Tully Road East Perth WA 6004 All Finance Broking services are provided by Momentum Wealth Finance Pty Ltd. Australian Credit Licence All Real Estate services are provided by Momentum Wealth Property Pty Ltd. Licenced Real Estate and Business Agent in WA TC53788.