Equity is your borrowing power, the amount of money you have in your home or investment property that you can use to purchase further properties.
This is the tried-and-true formula of property investing across Australia; tapping into dormant equity.
Technically speaking, it is the difference between the market value of your property and the size of your current loan. The bigger the gap, the greater the equity.
Over time, as capital growth pushes the value of housing up and you steadily pay off your loan, the amount you owe compared to the value of the property will widen and your equity grows.
How to calculate your borrowable equity
Calculating how much money you can borrow is a relatively simple task.
Just say you own a home that is worth $600,000 and you have a $300,000 mortgage on it.
That means you have $300,000 in equity, right?
Well yes, but now we need to make a distinction between equity and usable (borrowable) equity.
Most banks will cap their lending at 80 per cent of the property’s value, although you can go higher if you don’t mind incurring lender’s mortgage insurance.
Assuming you stick to the 80 per cent ceiling, let’s do the sums to work out how much you can borrow:
Your home’s value x 0.80% = $480,000
Your debt is $300,000, so subtract this from the amount the bank will lend up to $480,000 and you are left with $180,000.
This means you have $180,000 in usable equity.
What can you do with this equity?
Some people draw down this equity by increasing their home loan and use it to fund their home renovation
Others use it to fund that expensive European holiday they’ve always been dreaming about.
And many smart Australians have taken an equity release loan and used this as the deposit to buy an investment property to help secure their financial future.
But please be careful!
If you’re going to draw down your equity done just increase your existing home loan otherwise the interest on the loan may not be tax deductible.
It’s important to structure your investment loan correctly as a separate loan against you home rather than an extension of your home loan.
If done correctly the interest on this loan will be tax deductible, even though the security for the loan is your home, because the purpose of this loan is for investment and income producing purposes.