How Does Equity Work When Buying a Second Home?
Are you looking at buying a second property? You might have found your perfect holiday house or you are wanting to invest in property to rent it out. You might be looking to buy a house that your kids can live in. Whatever your reason for wanting a second home you might be wondering how you could afford it. Did you know if you are in the market for buying a second home, using equity to buy another house can allow you to purchase without a cash deposit? Sound too good to be true? We’ve put together this handy guide on using home equity to buy another house to answer all your questions. Let’s understand how equity works when buying a second home.
What is home equity?
First thing’s first. What is home equity? If you currently own a property with a mortgage, you will have been making monthly repayments towards paying off your home loan. The term equity refers to the value of your property minus how much you still owe on your mortgage.
Here’s an example.
You might have purchased your property for $550,000 with a 20% cash deposit and a home loan for $440,000. At time of purchase, you had equity totalling $110,000.
As you make repayments and the property market fluctuates, your equity available in your home changes. So, let’s say you have been paying your home off for 10 years – equalling $150,000 off the home loan’s principal – and your property’s value has increased to $900,000. In this example, you would have $430,000 equity to buy a second home.
How to use equity to buy second home?
Equity is a powerful tool for increasing your wealth and providing you with access to money if you need it. A lender will usually allow you to access up to 80% of the equity in your home. Using this equity can help in a number of ways including paying for renovations, paying of other debt or buying a second home using equity you have built up.
So, how do you access this equity so you can use it to buy another property? One way is to refinance your home loan – either with your existing lender or a new one – which will include the lender ordering a valuation of your property and allowing you to refinance based on the property’s new value.
Benefits of refinancing and using equity to buy a house
Using equity to buy second home with a refinance can give you a number of benefits including:
- Saving on interest repayments – refinancing to a lower interest rate can save you tens of thousands of dollars over the life of a loan.
- Have access to cash when you need it – a straight refinance will give you your nominated amount of cash into your bank account when the new loan is finalised.
Other ways to access your equity to buy a second home
Although refinancing is a great option to help you access your equity to buy a second home, it might not be right for you. If that’s the case, you do have other options to access your equity.
- Reverse mortgage – this entails borrowing against your equity without making repayments while you still live in your current home. This is geared at an older demographic so you may only qualify if you are of a certain age, and it is something to consider very carefully.
- Line of credit – this can be more expensive than a traditional mortgage, however, it can offer you more flexibility as it provides you access to a set amount of credit based on your available equity. Lines of Credit used to be popular, however they are fraught with danger in the wrong hands. They are also very expensive interest rate wise, as the banks have to allocate more capital towards these types of loans.
- Cross-collateralisation – this is when you use your equity in your current home as security for a loan on another property.
- Redraw facility – if your mortgage has a redraw facility feature, you can work at making extra repayments there and redraw the cash needed for a deposit rather than a refinancing arrangement which gives you a new home loan.
Using equity to buy a second home
Okay, so now you know the ways you can access your home equity, you might be wondering how it actually gets you that second property. Let’s take a closer look to explain.
Your existing lender, or new one if you are refinancing to a different lender, will determine how much of your property’s value you can use to buy your second home. It is crucial to get advice from a professional mortgage broker as early as possible so you know where you stand. Although you can go straight to your lender for a refinance, mortgage brokers are legally bound to work in your best interest and have access to a range of lenders to ensure you get the best outcome.
Your trusted mortgage broker – that’s us! – can help you choose the right lender and home loan product while also taking care of liaising with the lender for your valuation and all the paperwork needed.
How much equity do you need to buy another house?
Lenders will generally allow you to access up to 80% of your property’s value, minus what you still owe on the mortgage, so that valuation is key to knowing how much of your equity you can use to buy your second home. Bank valuations aren’t always the same as real estate appraisals so you definitely need to have your formal valuation completed to access your equity.
Once you have decided how much equity you need for your second home’s deposit, your mortgage broker can finalise the process of accessing your equity. If you have opted to refinance, the loan will go to settlement and you will then have the cash available in your bank account to start making serious offers on another property. If you opted for another method of accessing equity, your mortgage broker will assist you with the correct process and advise your next steps to use your equity towards buying your second property.
Using home equity to buy an investment property
***If you are looking to buy an Investment property, there are a lot of different ways and strategies in which to purchase these from a finance, taxation and risk perspective. It is important you get advice and know what will suit your situation best.
Whatever your reason for wanting to buy a second home, chatting to an experienced mortgage broker will mean you know exactly what your options are and how soon you can buy another property. Reach out anytime for specialist advice for how to use equity to buy a house.