When it comes to purchasing a new property, saving for a deposit can often be one of the biggest hurdles for prospective buyers. One strategy that some homeowners consider is using the equity in their existing property as a deposit for their next purchase. But what exactly does this mean, and how does it work?
What is Equity?
Equity is the difference between the current market value of your property and the amount you still owe on your mortgage. For example, if your home is worth $600,000 and you owe $400,000 on your mortgage, your equity is $200,000. This equity can potentially be accessed or leveraged when buying another property.
How Can Equity Be Used as a Deposit?
Instead of saving a cash deposit from your income or savings, you may be able to use the equity in your current home to help fund the deposit on a new property. This is often done through a process called a home equity loan or line of credit, which allows you to borrow against the equity in your property.
By tapping into your home equity, you can increase your borrowing capacity and reduce the amount of cash you need upfront. This can be particularly useful for investors or those looking to upgrade their home without waiting years to save a deposit.
Things to Consider When Using Equity as a Deposit
- Loan-to-Value Ratio (LVR) Limits
Lenders typically have limits on how much you can borrow against your property’s value. Most lenders allow borrowing up to 80% of your property’s value without requiring Lender’s Mortgage Insurance (LMI). If you borrow more than this, you might need to pay LMI, which protects the lender but adds to your costs.
- Impact on Your Existing Mortgage
Using your equity means increasing your overall debt, which can affect your repayments and financial flexibility. It’s important to ensure that you can comfortably manage the repayments on both your existing loan and any new borrowing.
- Risks of Using Equity
While using equity can speed up your property purchase, it also carries risks. If property values fall, your equity can decrease, which might affect your ability to refinance or sell. Additionally, borrowing more increases your exposure to interest rate changes.
- Purpose of the Funds
Lenders will often want to understand how the equity will be used. Using equity for property investment or home improvements is generally acceptable, but using it for high-risk investments or non-essential expenses may be scrutinised more closely.
- Costs and Fees
Accessing your equity may involve additional fees such as application fees, valuation fees, or legal costs. It’s important to factor these costs into your overall budget.
How to Access Your Equity
To access your equity, you generally need to:
- Have sufficient equity in your property (usually at least 20%)
- Meet the lender’s serviceability and credit criteria
- Have your property valued by the lender or a qualified valuer
Once approved, funds can be released as a lump sum or a line of credit, depending on the product chosen.
Regularly Review Your Equity Position
Property markets and your financial situation can change over time, so it’s wise to regularly review your equity position. This helps you understand how much you can borrow and plan your property goals accordingly.
Disclaimer: This blog is for informational purposes only and does not constitute financial advice. The suitability of using equity as a deposit depends on individual circumstances, and it is recommended to seek personalised advice from a qualified mortgage broker or financial adviser. Lender eligibility criteria apply.