There’s one thing that is said to come with age, and that’s wisdom. As we grow older, our experiences help shape better decision making skills whereby we weigh up advantages, disadvantages, risk, opportunity and reward. There’s no denying it, the decisions you made in your youth will have followed you into adulthood. One of these decisions may have been taking on a mortgage. Now that’s not to say that the mortgage was necessarily a good or bad decision, but it’s a financial commitment nonetheless. As a financial commitment, the requirement to make regular repayments could make it difficult for you to acquire another home loan that would support your break into property investment as soon as you’d like. Equally, if you bought your first home in the last 5-10 years and have a desire to become a property investor, it can be challenging to calculate whether your earnings could support another loan if you haven’t made the appropriate plans. This is a common scenario that could constrain you from jumping on opportunities to purchase a second home, generally the due to a lack of savings. Ultimately, you’ve worked hard to enter the property market and are working even harder to build your property portfolio. So how do you invest in property without a deposit?
As you work hard to pay off your mortgage, support your family and have spare money to enjoy, the reality of saving up for another deposit can be quite daunting and difficult. However, there is a way to grow your property portfolio without the large cash outlay, by using your home equity. Over time you build up equity in your home as you make repayments. You can then use this equity to secure your next property without a deposit.
Equity refers to the dollar value associated with your property that is owned by you and not the bank. If your house is worth $700,000 and you have $300,000 left to pay back on your home loan, then your equity would be $400,000; pretty simple, but you probably knew that already.
As you pay off portions of your mortgage each month, the amount of equity you have increases by the same amount as you repay because you now own more of your house and the bank owns less. Picture it like a set of scales; as you pay off more of your mortgage, the banks side of the scales becomes lighter and your home equity side becomes heavier.
When it comes time to finance your first home you will traditionally need to provide a deposit as security. This deposit acts as a commitment to your lender that you will pay back your mortgage. In the instance you already own a property and assuming you have paid some of it off, you will be able to use this equity as security for your next house. This means you will redraw equity from one property, and then use this cash as a deposit for the next.
Here is an example from one of our customers, Ben. Ben is going through the exciting process of planning to purchase an investment property for $400,000. Without security, he would need a minimum deposit of $40,000. Ben has an existing mortgage on a home he has been slowly paying off over the years. This is his financial position:
Instead of having to save up $40,000 for a deposit, Ben is able to take this equity from the amount he owns on his existing home. This $40,000 is redrawn from his current mortgage, meaning he now owes $380,000 on the existing mortgage. After this transaction, the property’s available equity is reduced to $160,000. When home equity is not utilized, as the borrower, you could be missing out on a great investment opportunity which could produce returns that far exceed the benefit of reducing the interest repayments on your existing mortgage. Ben now has $40,000 equity in his investment property which has the potential to grow in the future, making for an investment with proven and measured, risk and reward.
The above diagram helps represent that although Ben has lost $40,000 in equity from his initial property; he has gained $40,000 equity in his investment property. Ben still has a total equity of $200,000, however this is now split between two properties. Restructuring his finance allowed for the no deposit investment mortgage where his only focus now needs to be on repayments.
The same process can be followed to purchase more properties in the future, and is the strategy many property moguls use to build their extensive property portfolios.
The concept is simple: leverage someone else’s equity instead of using your own. We understand that you may be in a position where you don’t currently own a home meaning you wouldn’t have any equity. In this case, you could use the equity that your parents have in their home and have them go as guarantor. This is essentially a way of your parents backing you for your first home where their equity acts as the deposit. Note that you will pay back the bank, not your parents.
A great way to use this to its full potential is by renting the property out while still living with your parents and use the rental income to pay down the mortgage faster. Once you reach 80% LVR (or in other words have paid off 20% of your mortgage), then refinance, put the home loan entirely under your name and then move in! Buy first, and then build your deposit later.
Why purchase an entire house when you can purchase it one brick at a time. It sounds crazy, but some online sites, such as BRICKX, now provide a service where you can buy and sell ‘bricks’ in a property. Treat these ‘bricks’ like shares in a company where several investors buy a portion of the business; except, in this case, you are buying a share of a house. With each ‘brick’ starting at around $60, it gives you the freedom to choose how much money you invest. Just like owning an entire investment property, you will see both rental returns and capital growth, however at a lower rate seeing as you only own a portion of the house. The more ‘bricks’ you buy, the greater the potential return.
On this note, why buy one house when you can diversify and invest across the country. This is made possible by investing into a real estate traded fund, where you buy shares in the fund on the Australian Stock Exchange. This fund then owns property across all of Australia, meaning that you would own a small part of all of the properties. When the property market is doing well, the value of your shares would go up and vice versa. It can also have its benefits seeing as you don’t have to manage the property or make mortgage repayments, the fund would take care of this for you.
When it comes to property investing, this isn’t our first rodeo. We love seeing Australians get ahead with their finances so much that we wrote an entire eBook on this topic. To learn more about property investing, see our Super Powered Property Investment Guide!