An investment property is not a piece of land that you can call an asset, but it is a mine of multiple opportunities. Yet, you need to find a key to unlock each opportunity. For real estate agents, this key is equity.
What is equity
Equity, in layman’s terms, is the value of the property after deducting debts from it. It is the value or a part of a property that solely belongs to you.
For instance, you bought a property whose worth is $500,000 and a mortgage balance is $300,000, so $200,000 is equity. It means the property share that’s worth is $200,000 solely belongs to you.
As you pay your mortgage amount regularly, the debt will reduce, and equity will increase. With time, equity increases as the property value increases because as the property value increases, the share you own also increases in terms of its worth.
Equity changes as per the market trends; therefore, it is important to understand how to calculate equity and use it for property investment.
How to maximise equity of your own home?
Equity can be maximised either by paying the mortgage amount or improving the property value. Here’s how you can utilize these two principles or one of them to drive equity.
Additional mortgage payments
The faster you pay your mortgage amount, the sooner your equity will increase. If you start paying a higher mortgage amount every month regularly, you will double your equity soon.
Home renovation
Maintaining and managing your home to keep it up-to-date will improve its value with time, leading you have to growth in equity. For this, you can have a fresh layer of paint every year or upgrade the kitchen and bathroom timely manner when required to elevate property value potentially.
Decade-long ownership
There is a five-year rule in real estate according to which the value of the property will go up if you own it for more than five and short-term losses won’t affect it. Eventually, it means the equity will rise if you own the property for a longer time.
How to use equity for investment property?
Smart utilisation of equity paves the way for investing in a property. But for this, you need to understand what usable equity is. Usable equity is the value or worth of the property that you can en-cash against the property.
The cash you get by using equity can be used to get an investment property. In most cases, people go with debt recycling to use their equity against money.
What is debt recycling?
It’s a strategy in which you can change non-deductible debt into deductible debt, aiming to show the association of your debt with an income-producing asset. Once you show it, the interest rate on your debt will become tax-deductible.
By following this strategy, you can assess your equity via a line of credit against your home.
Since you will use the money you get from the line of credit on investment property, the interest rate on it will be tax-deductible. Yet the mortgage on your home will be non-tax-deductible because it is a non-income-generating asset.
Debt recycling will let you expand your portfolio while reducing tax on your investment property, but you need to plan and manage your debts while keeping your current financial circumstances based on your investment goals to understand your risk appetite.
What are the advantages and disadvantages of debt recycling?
Debt recycling has both good and bad points. Let’s discuss its merits and demerits before leveraging equity for investment purposes.
Advantages
- You can expand your portfolio without the requirement of another deposit.
- Your tax position will improve because of having tax-deductible interest.
- You will generate better rental income with time.
Disadvantages
- Debt will increase for you
- Decrease in property value will result in negative equity, which will eventually bring more pressure to your budget than expected.
- Financial stability will be at stake if you borrow and leverage excessively.
Debt recycling does not decrease debt on you; therefore, you need to carefully manage your investment and ensure you will earn from the property on which you are spending your loan money.
How to know if debt recycling is good for me?
Well, you can only give an answer because it depends on how stable you are financially. If you are living paycheck to paycheck, don’t go for leveraging equity and debt recycling because you are far from financial stability. Debt recycling will result in more debt, which ultimately puts a strain on your budget and running expenses. If you have a consistent income source along with good savings, then go for it.
After determining stability, ask yourself what your financial goals are because leveraging equity won’t give you results in three or four months. You will get your dream results of earning from your property after a year or two, so you have to ensure this debt recycling strategy aligns with your objectives and timelines.
Besides, observe your habits to manage and maintain risk tolerance. If a small risk brings a shiver down your spine or gives you a gush of blood, it is better to avoid using equity for investment property via debt recycling. After all, debt recycling’s given burden will stay with you for two years minimum! If you can handle it, go for it, or look for another option.
Conclusion
Equity is a key to unlock the opportunity your investment property offers, but it requires understanding the basic concepts of usable equity and debt recycling. Usable equity is the worth of the property that solely belongs to you after deducting debts and mortgage from it. With time, your equity value increases as you pay the mortgage amount and as your property value increases.
You can use your equity against your home to get a loan, which you can use to invest in a property by showing it investment property to make interest tax-deductible.
Debt recycling is an enticing method, but it won’t reduce debt; instead, you will have more debt to pay. So, before going for this strategy, ask yourself
- If you have savings and a consistent income source
- If you can tolerate risk for more two years at least
- If this aligns with your investment goals.
The answers to these questions will help you make the decision that will bring effective results that you aimed for in the long run.
You can now use this part to invest in further properties by using it against cash but for this you need to understand the complicated mathematics and investment sciences behind it.
