Aug 04, 2016
Equity: Your Super Power!
Superman has X-ray vision, Batman is a master of martial arts, and Spiderman can climb walls.
Even Banana Man gains super strength after gulping down a bendy yellow fruit!
Superheroes have super powers, but of course they’re not real. Now let me introduce to you a super power that is real: equity.
This super power can create wealth from a single deposit, and it can duplicate properties at the Speed of Light – okay, well almost!
Most importantly, it can set you up for a prosperous future.
DID YOU KNOW?
The deposit for your first property is the only time you need to save up to buy a property. Welcome to the world of equity and duplication!
If you ask 100 people what’s the most difficult thing about buying a home or investment property, 99 will say it’s saving up for the deposit.
The fact is, there’s no easy way around it. Most of us do it tough by saving every dollar we can for a few years. If you’re lucky you might get some help from your parents or come into an inheritance.
But whether you’re buying a home to live in or an investment property, one way or another that first purchase will need funds up front from you.
WHAT IS EQUITY?
Think of equity as the difference between the market value of your property (this is usually determined by a bank valuation) and the amount of the mortgage loan owing on it.
Equity is created from the consistent increase in property values, which has happened historically across the country in well-located suburbs.
As your property increases in value over time, so does your equity – without you lifting a finger!
HOW TO USE IT
You can make the most of your equity gains by refinancing your mortgage and then using your equity as a deposit for another property. This creates the power to start an investment property portfolio.
You can build equity even faster by paying more than your standard mortgage repayments. Every dollar you pay is another dollar in equity that you can use!
Capital growth combined with paying off your mortgage ahead of schedule has a Super Power effect. It can provide tax benefits too. I recommend ‘interest only’ investment loans for tax purposes.
Another equity Super Power is duplication. It’s a favourite word of mine when it comes to building a property portfolio.
If you buy one property, the capital growth will give you the equity to buy a second property. Once you have two properties, you will be generating two lots of capital growth, so you can buy two more properties. That’s four properties!
Then four properties become eight properties, and so on. All starting with that one deposit! This is why I call equity a Super power!
Here’s how it works. Let’s say you bought your first home two years ago for $400,000 and it increased in value by 10 percent over each of those two years. Your property would now be worth $480,000. For this scenario I’ll assume that taking into account your deposit and repayments, the mortgage owing on it is $300,000. That gives you a total equity of $180,000 in the property.
You can’t use the full amount, though. Banks being very conservative, they generally base their loan calculations on 80 percent of a property’s value. It can be higher if you pay lender’s mortgage insurance (LMI).
So based on an 80 percent loan from your bank, your actual available equity is $144,000 (80/100 x 180,000). You can use that amount to buy your next property.
You can purchase a new property with an 80 percent loan, and then use some of your $144,000 equity to make up the balance, which will be 20 percent deposit plus other costs like stamp duty, legal fees, etc.
You’re now on the way to owning two properties! Even though you’ve only paid the one initial deposit you saved up, its capital growth has paved the way to buy your next property.
A tip here is to buy your second property with a loan from a different financial institution from your first. In fact, I recommend going to a different lender with each new property purchase. The reasons for this are explained in my article about Serviceability.