Leverage your Equity for a secure financial future
Equity is one of the most powerful ingredients if you want to create wealth and retire financially free. But it's often a term that is misused, misunderstood, and worst still not acted upon.
What is Equity?
Equity is the difference between your property's value and the amount you've borrowed against it. This equity can be calculated by subtracting the balance you owe on your mortgage from the current value of your property.
Let's say your home is worth $700,000 and you have $350,000 left on your mortgage, you're actually sitting on $350,000 of equity. And thanks to the fact that the property market has experienced a boom over the last few years, many Australians possess quite a considerable amount of equity.
Most of us have been led to believe that debt is just an ugly four letter word. However taking on the "right type" of debt and putting your equity to use is the only way you'll ever become financially free and not have to worry about money ever again (unless of course you win the lotto or inherit a major inheritance!).
If you have equity in your property and not doing anything with it, then you're sitting on lazy equity. The only way to create more wealth in a predictable way is to leverage your equity by borrowing against it (safely) and buy high growth investment assets that will make you more money over time (like residential property).
Borrowing Equity vs Equity
It's common for borrowers to draw out cash by refinancing their current home to access their equity. However your borrowing equity differs from your actual equity.
Let me explain. If we use the above example, the borrowing equity in this instance is $280,000 based on an 80% LVR (i.e. $350,000 x 80%). Some banks and lenders will allow you to access your equity a little higher to a 90% LVR, however the point I am making is that your borrowing equity ($280,000) is never 100% of your actual equity ($350,000) as banks allow a safety buffer as precaution.
This borrowing equity of $280,000 can then be used as your cash contribution (e.g. deposit and purchase costs) towards the purchase of another property. Some people tap into their borrowing equity for other purposes such as a significant renovation to their home to increase its value, to fund educational expenses, a new car, a vacation, to consolidate debts or pay for other unforeseen circumstances such as medical costs or job loss. This is OK so long as you have a plan in place to extinguish your personal debt fast.
Borrowing against your equity to purchase investment assets is the secret formula to creating wealth in a predictable way.
It's also very important to seek advice from a qualified Finance Specialist to ensure that your loan portfolio is structured correctly as there are tax implications if you lump all your borrowings together (e.g. home loan debt lumped in with investment related debt). The wrong loan structure can cost you thousands and can put you on the wrong side of the law.
Benefits of using your Borrowing Equity
As I've explained unlocking the equity in your home can be an effective way to assist in purchasing a rental property to help build your wealth. Residential investment properties can be a popular investment, having the potential to provide investment security, capital growth and rental income. There may also be tax advantages. Negative gearing and depreciation allowances are also popular ways to reduce your tax liability, especially at the end of the financial year.
You should consult your financial and taxation advisers before determining if this strategy suits you.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
