The Ultimate Guide To Renovation Course - Module 5: Savings & Equity

So let's have a look at where your money comes from. It usually comes from one of three places, savings, a gift or equity. So let's get to where we are right now. You've gone out, you've done your budget and you've got your spending under control. You've reduced your credit card limits to what you really need, and you've reviewed your credit file. Now you need to think about where the money is going to come from to finance your investment, property purchase and renovation. Essentially, it will come from either your savings or from unlocking the wealth that's been building up in your home in the form of equity. If you're lucky, you might even have a family member who may be prepared to help you by using their own property as a guarantee. But realistically, that option is not very common. The funds you will need to contribute to a property purchase will be 5 to 20% deposit, plus additional funds for your legal fees, disbursements and stamp duty. Firstly, let's look at how you might use your savings to fund part of your purchase. This is the savings model. This is the traditional way that mums and dads bought their first home. They saved like mad for a deposit, and then when they had enough, they applied for a loan. How much is enough, Though, as you've seen previously, it really depends on the lender. As a rule, you need to consider two things. Firstly, you need to show three 5% of genuine savings in your bank account to demonstrate to a lender that not only are you capable of saving, but also that you'll be able to afford the loan repayments, which, while this is usually only strictly required for those who are borrowing over 90% of the loan to value ratio, that is those that have less than a 10% deposit. Lender policies do change regularly, so be prepared. Make sure that you have the money available for a time frame to prove that you have genuine savings. Let's look at the second. You need to have the funds necessary to complete the purchase in a bank account. For example, for a $400,000 property with a 90% loan to value ratio, you'll need a 10% deposit, $40,000. You'll also need approximately $15,000 to cover the stamp duty. Now, this varies from state to state, but for this example, it works. So, in total, you'll need to show that you have at least $55,000 in your account. If you want to contribute a 20% deposit, then you'll need more than $95,000, $80,000 for the deposit and that $15,000 in stamp duty. Now, I'm assuming that the lender will allow you to capitalise your LMI premium, your lender's mortgage insurance. This can vary anywhere between $3,000 and $30,000, depending on how much you loan and how much your loan to value ratio is. So you put that on top of the loan. Most lenders will allow you to do that. Let's have a look at the equity model. I love this. If you've already got a home commonly referred to as your principal place of residence, and have been paying the loan off quickly, thereby reducing the total amount of interest you'll pay over the life of the loan, then assuming your property has increased in value, you probably have some equity available. Unlocking this money or equity tied up in your principal, place of residence or even another investment property is the easiest way to buy your first investment property. Now, it usually depends on what you can afford and the repayments you can make. Lenders will allow you to utilise the unused equity in your property. But you need to know and be able to calculate what this is. So let's work through an example. You purchase a property for $200,000. Using a 20% deposit of $40,000. You took out a loan of $160,000. That's a loan to value ratio of 80%. The market value of the property is now $300,000. Your original loan of $160,000 has been reduced to $100,000, giving you now a loan to value ratio of 33%. That's the $100,000 loan divided by the $300,000 value. Loan to value ratio 33%. Now, to calculate the new equity available in the property, you need to decide how much equity to leave in the property. For this example, let's assume that the loan to value ratio will be returned to the 80%. So you're not incurring lenders mortgage insurance. Obviously, if you want to be more aggressive, you might increase that to maybe 90%. So based on an 80% loan to value ratio, the the available equity is calculated like this. The value of the property, $300,000 times 0.8 equals $240,000 of equity. That's your total equity. We've left 20% in the property untouched. Now, I want you to think of this 20% as a kind of buffer for the lenders. It's kind of their sleep at night factor. They want to make sure that if the market drops, that your loan is still under the amount of the value of the property. Now, Looking at this, I want to take this a little bit further for you. We've talked about what the total equity is the $240,000. But don't forget you still have a loan of $100,000. So you've used up $100,000. So we take your total equity available. So the value of the Property times the 0.80% of $240,000. We minus your current loan amount $100,000. The equity that you have available is $140,000. Now as I said, you need to be able to service that debt as well. And that will go into the calculations that the lender uses to look at if they'll give you that money. Let's have a look at an exercise. Work out how much equity you might have in your home, your PPOR by using the following Total equity equals the current property value minus the outstanding loan amount. The available equity however is the total equity times 0.8. That is we're leaving 20% equity untouched as a buffer minus the loan amount. Now if you're happy to incur lenders mortgage insurance, work out how much equity you can tap into. If you took a 90% loan for instance, here's a hint on that calculation. Just substitute the 0.8 for a 0.9. But remember, lenders mortgage insurance will be charged, but you can put it on top of your loan in most instances. So how much equity do you really need? You need to decide how much equity you want to take out from your property. It's important to consider the amount you'll need for this purchase and also for the purchases that you intend to make over the next three to five years plus a buffer and your renovation costs. That is all the figures that we calculated above. If you're accessing equity to buy another property, and if your goal is to purchase a further property in the next three to five years, then you should factor into your finance application now. Not just the purchase of the property now, but the one in the future as well. So why is the equity model beneficial? Releasing equity from your home in a structured way allows you to keep your savings in the bank. Most investors want to combine the benefits of utilising none of their own savings with tax minimisation advantages when buying an investment property. Accessing equity in your home or current investment property allows you to leverage your current situation and to use the lenders funds to assist you with than buying a property. Hence buying you time in a growing market. The more exposure you have to a growing market, the more opportunity to grow equity and in the long term, the more equity you have to help you fulfil your goals. Bear in mind that geographic markets do not all grow at the same time or at the same rate. So spreading your exposure and therefore your risk across different states, towns or suburbs is one investment strategy to to reduce risk. Obviously you also need to be able to service any new loans and maintain an acceptable standard of living. Accessing equity is a clever technique. It allows you to use the money you have put into paying off your loan and also the capital growth you have gained rather than your savings to assist you in achieving your financial goals. So let's just leave your savings there as a buffer. So what is a buffer and why do you need one? Most people just tap into the full equity available to ensure they have a buffer and access to the funds that covers them for a few years to come. You too might choose to do this, but you need to understand why you need a buffer. I believe it's important to include a buffer when you're calculating the amount of funds you want to release from your equity. It's also important to consider this in alignment with your personal circumstances and and property investing strategy as an alternative to the suggestions below. You could also use your savings as a buffer if you don't want to take additional funds from your equity. We discussed earlier that when setting up your initial equity tap, you need to consider not just this purchase, but also your investment strategy for the next 35 years. If your property investing strategy calls for a renovation or you plan to buy something for personal use, a car or holiday, or even renovate your existing home, then then an additional amount should be included in the initial funds you are seeking from the equity that you have available. When applying for these funds, you should also consider factoring in a buffer to protect you against unforeseen circumstances such as an incapacity through illness or injury, you or your partner losing your job, or the loss of the rental income, any of these circumstances could mean you will have to temporarily dip into your own savings to cover repayments if you haven't accounted for those with a buffer. But how much should you include? Because you can only access equity from an existing property, this property is either going to be a home or an investment property and the purpose of accessing equity will be either for a new home or a new investment property. Or it could be for expenses such as renovations for an existing investment property. Either way, the equity access has to be used for investment debt. If you are buying a new home and accessing equity from an existing home or investment property, you will most likely need a buffer based on the potential of that. You could lose your job or the existing property may lose its rental income. What I'm talking about is, you know that available equity that we said that you could get out of your property, don't use it all up. Leave a little bit there, there for the just in case circumstances. It's important as an investor that if things do go wrong, that you don't have to go through a fire sale and sell a property in a market you don't want to be selling in. If you can't afford to keep that property, the buffer buys you a little bit of time whilst you set yourself up to either sell the property or get a new job or just get better. So what I'm saying is, when we're talking about accessing equity from your current property and, and using it to buy not just this property, but potentially the next property, leave a little bit of money in there to give yourself a buffer as an alternative. You might have a lot of savings that you could use for that, but you just need to make sure that you minimise the risk so you're not having to sell your property when you don't want to.