Time to tap in to some equity and keep investing: Todd Hunter

GUEST OBSERVATION

The performing Sydney and Melbourne property markets are no secret. They are all over social media and the news.

And for those home owners and investors who have had the great fortune to see their property values skyrocket, what’s next?

Why not take advantage of the fantastic values currently on offer and tap into some of that equity and keep investing?

But what does “tap into our equity” actually mean?

Similar to when you purchased your property, the banks would only allow you to borrow up to so much of the value of that property. This is called your Loan to Value Ratio (LVR). Well, provided you can service the debt at the increased amount (make the repayments), the banks will allow you to increase your loan up to a certain LVR and use that cash for a deposit on an investment property.

The great part about that is, that the increased amount that you use as the deposit on another property is tax deductible, even though the banks used your home as security for the funds.

Why?

Purely because what makes a loan tax deductible is the purpose for which those funds were used.

Like usual, let’s number this out.  

Say three years ago your home was worth $600,000 and your home loan was $480,000. Your LVR is 80% because $480,000 is 80% of $600,000. But in the last three years your home has seen some great increases in value and it is now worth $850,000.

The banks will now allow you to increase your loan to 80% of $850,000. So your new loan would be $680,000. But you only owe $480,000 so there is $200,000 available for you in available funds, in your offset account or in redraw ready for you to use when you locate another property.

Now to keep your accountant happy, it is best to split the $680,000 into two loans, one split for $480,000 and the second as $200,000. That way your accountant can easily work out the interest on the loan that they can claim on your tax each year.

Obviously, this is how we would structure your loan and explain all this to you as we go.

At the same time as arrange the extra cash for you to use as a deposit, we would arrange a pre approval for you so that you could purchase an investment property.

Even if you have some extra money paid off your home loan, do not use this but instead continue to make the extra repayments on your home loan to pay this off first. Simply because this debt is not tax deductible.

You should restrict the maximum amount you aim to spend on an investment property, and that should be nowhere near the value of your home.

Even as a professional investor I don’t spend over $425,000 on a property. My last four purchases were for:

• $410,000 – ACT
• $40,000 – in the USA
• $356,000 – QLD
• $134,000 – Tassie

The advantages of spending less are:

• Diversify
• Less to lose, if by some chance everything turned pear-shaped (always invest with worst case in mind)
• Potentially be able to invest in different markets and take advantages of different property cycles
• Baby steps – especially if this is your first go, I see couples where one of them wants to invest much more than the other, and it’s not worth fighting over. You’ve only got one life and it ain’t no dress rehearsal. (Sorry if I just went all Dr Phil on you)
• Yields are generally more attractive and the properties will pay for themselves

So back to the story, we have set up a pre-approval at the same time for you for a purchase price of $375,000. The loan would be for $300,000 which is an 80% LVR.

But there are some set up costs along the way to, for example:

• Stamp duty – varies state to state
• Legals to purchase
• Building inspection report
• Pest nnspection report
• Depreciation schedule report – for tax purposes
• Government charges
• Buyers agent fees – because you will want me to buy you a property

The great thing here is that you can pay for all these from the $200,000 loan you have already set up.

Yep, that’s right nothing from your pocket and the interest these fees attract on that loan is also tax deductible.

Now to make that transaction work you only require around $100,000 and you have borrowed and extra $200,000, meaning you have the option later on to possible purchase a second investment property. But by tapping into the equity now whilst the values are high, could give you the option at a later date. When values go through a correction you may not get that privilege. And you only pay interest on the money that you have used, e.g. the $100,000.

Now, not everyone is in a position to tap into their equity and invest, as they may have borrowed 95% of the purchase price when they recently purchased.

What you may have been experiencing, is that there are some much better interest rates on offer. They can be as much as 0.5% better.

So what can be done about this?

Firstly, interest rates are now allocated as rate for risk, meaning those higher risk borrowers to the banks are not on the same interest rates as those borrowers who own 20% or more of their properties.

And this risk is judged on the value on the day that a valuer puts a dollar figure on your property. So as we have experienced some great growth in the Sydney and Melbourne property market, you may now find that you do own 20% of the property value now.

But be quick, because this great market isn’t going to stick around much longer and you want to capitalize on the maximum value you can achieve.

TODD HUNTER is buyer’s agent, director and location researcher for Sydney-based wHeregroup.