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what to do with home equity

understanding equity and investing in a second property

BE READY TO MAKE A MOVE BECAUSE WHEN THE MARKET SHIFTS – IT ALSO GETS COMPETITIVE!

HOW TO CASH OUT ON THE REAL ESTATE BOOM IN NORTH TEXAS​

The US Residential Market’s recent achievement of hitting a whopping $52 Trillion and showing a strong rebound is not just another statistic; it’s an indicator of the health, resilience, and potential of the real estate world. But why should you, as a potential buyer, seller, or investor, care about this? Let’s break it down:

WHAT YOU NEED TO KNOW​

If you purchased a home in North Dallas Fort Worth (DFW) two or three years ago or more, there’s a high probability that you’re sitting on a good chunk of change in equity that can and should be re-invested as soon as possible. This may seem like an overwhelming undertaking but our team is here to help.

The first step is understanding what equity is and how to use it to your advantage.

How does equity work when buying a second home?

Equity is the difference between the current value of your property and the amount you owe on it. You can buy a second home without cash for a deposit by using the home equity in your existing property. You do this by borrowing against the equity through a refinance to borrow more money.

For instance, if your home is worth $500,000 and you owe $200,000 on your home loan, you have $300,000 in equity.

Equity increases in two ways. First, you build equity by making your regular principal and interest repayments. The more you pay down the principal of your home loan, the more equity you create.

The second way equity accrues is through your home rising in value. If you paid $500,000 for your home several years ago and it’s currently valued at $700,000, you would have accrued $200,000 in equity through capital growth.

Here’s a more detailed example:

You bought a property in 2017 for $500,000

Your deposit was 20% or $100,000

Your initial loan was therefore $400,000

You’ve paid $50,000 off the mortgage principal by making repayments to the loan

This brings your loan balance down to $350,000

Today, the property is valued at $700,000

Your total equity is the property value ($750,000) minus debt ($350,000)
So your equity = $350,000

Lenders will typically let you borrow up to 80% of your property’s value before they charge Lenders Mortgage Insurance.

So in the example above, the total amount you could borrow is 80% of $700,000, or $560,000.

Since your existing loan balance is $350,000, this means the amount of equity you can access is $210,000.

How to finance your second home purchase

Working out your equity is one thing, but how do you actually access it? There are several ways, including refinancing your home loan, taking out a line of credit or using savings from an offset account as a deposit and taking out a new loan.

Refinance

Let’s use the example above, where you have $210,000 in equity to borrow against. You approach a lender about refinancing in order to purchase a unit as an investment property. The unit costs $400,000.

You borrow against your equity to cover the deposit, stamp duty and other costs. In total you need $420,000. The total amount you borrow is $320,000 against the new property, and $450,000 against your existing home ($350,000 to pay out the existing debt, and $100,000 towards the new purchase).

The lender agrees and you proceed with getting the loan. 

Line of credit

If you have a significant amount of equity in your home, a line of credit loan could account for most or all of your deposit.

A line of credit loan only requires you to pay the interest portion of the loan, until you reach your credit limit. You can use as much or as little of the credit limit as you like, and only pay interest on the amount you use. This can be a tax-effective strategy for investing in property, because it maximizes your tax-deductible debt by allowing you to make interest-only repayments.

While a line of credit loan can help you invest in property sooner and carries significant tax advantages, there are some drawbacks:

  • Using a line of credit loan to invest in property could potentially see you managing multiple home loans: your owner-occupier home loan, the line of credit and an investment loan.
  • The interest rates can be higher than standard residential home loan rates.
  • You’re using your own home as security against an investment property, which adds risk.
  • Because you don’t have to repay the loan immediately while the interest accrues to the limit of the line of credit, you’ll ultimately pay more in interest long-term.

Compare line of credit loans.

  • Make sure your finances are in order before buying a second home

You may have plenty of equity to play with, but you don’t want to jeopardize the wealth you’ve built up by making a poor decision.

Whether you decide to refinance, top up your existing home loan or take out a line of credit loan, you’ll be making larger repayments. This will require careful budgeting to ensure you can service your loans.

If you’re investing, make sure you do your research to determine how much rental income you’ll be able to generate versus the expenses of managing the property and servicing your new debt.

You can use this investment property tax spreadsheet to work out the sums for the income you’re likely to generate versus your expenditure. Once this is determined, budget wisely to ensure you will be able to comfortably manage any extra expenses. If your cash flow is positive, you’re in a good position. 

Understanding the tax implications

For tax purposes, your home is considered your principal place of residence. You don’t have to pay capital gains tax when selling your home. But if you own a second property you will have to pay a tax on the capital gains when you sell it if you’ve owned it for under two years.

With an investment property you can deduct many property maintenance costs from your taxable income. With a holiday home, you can only deduct expenses if you also rent out the property. Claiming deductions on a holiday home can therefore be complicated if you use the holiday home yourself but also rent it out at other times.

Buying a new home and selling the old one

Not everyone is buying a second home as an investment, or buying a new home and keeping their existing property as an investment. Some people just want to upgrade by selling their existing home and buying a new one.

But it’s hard to get the timing right. You need to find a new property to buy, find a seller for your old home, and try to time the settlement days for each so you can have the money from the sale on hand to cover the new purchase.

If you’re in this second home buying scenario you have some options to make it easier for you:

  • Be flexible on settlement dates. Try to be as flexible as possible with your settlement dates, and be sure to check this in advance with the people you’re buying from and selling to. The longer the settlement window on your sale, the more room you have to move.
  • Use offset savings. If you’ve made significant savings through your home loan offset account you can easily pull this cash out to form part or all of your deposit. This can let you buy a second house before you’ve sold the first. Just keep in mind you might get stuck paying off two mortgages if you can’t sell your old home fast.
  • Consider a bridge loan. Bridge loans are financial products designed specifically for people in this situation who are caught with a shortfall or gap between their sale and purchase settlement dates.
Our partners at Bob Mortgage have amazing financing solutions and are happy to create a plan that helps you begin creating a wise investment portfolio from real estate. Give Bob Johnson a call by clicking the number below. Let him know Emily & Jason Albernaz with Live in Texas Team sent you! 

 

Resources

Stay in the loop with more market insights and trends from the Live in Texas Team. For personalized advice, tailored to your real estate needs, don’t hesitate to reach out. Visit facebook.com/liveintexasteam and instagram.com/liveintexasteam for real time updates on social media or call/text us at 430-588-0080.

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