Our Managed Chief Exec Thom Richards chats with Matt Dimos, one of Yellow Brick Road’s leading brokers, about accessing existing equity to grow your property portfolio.
TR - At Managed, we find many of our new clients come to us not really knowing the true value of their property and they often have no growth strategy in place for their portfolio. I want to explore some of the options available to them when it comes to capitalising on existing investments and adding new properties to their portfolio.
One way an investor can expand their portfolio is to refinance. Matt, what do you gain from refinancing a property?
MD - Refinancing can help unlock your equity. Equity is essentially the difference between how much your home is worth and what you owe on your home loan. If you've got $200,000 left on a mortgage when your home is worth $500,000, then you have $300,000 of equity.
Equity accounts for both what you've paid off your home loan and the growth in a property's value over time - the higher the capital gain, the more equity you'll have.
Once you've calculated your equity, you can determine how much you're able to access. This involves reworking your home loan, and many lenders won't let you tap into all of your equity - you will still have to comply with LVR limits. This is why financial advice is crucial before you move forward - you have to know exactly what you can borrow, and what your plan is for those funds.
TR - Are there any real drawbacks to refinancing?
MD - There are numerous fees and application costs that can make refinancing an expensive and tedious process. We encourage all investors to explore any exit costs associated with their current loan (discharge fees, deregistration fees) and also chat with a broker regarding the potential costs (application costs, change in rates etc) and application requirements for the new loan. You need to ensure this is a worthwhile exercise.
TR - Ok, so let’s presume you have now weighed up the pros & cons of refinancing your existing home or investment and it makes sense to use some equity to buy another investment property. What next?
MD - The first step is to ensure you have a clear idea of what your goals are. For example, some properties are more geared towards capital growth – meaning it increases in value over time. Others are better for a higher rental yield. Your life stage will dictate what’s best for you. Generally, those saving for future wealth prefer capital growth, while retirees or those who aren’t working will need a higher income. Decide what you need, as this will dictate the type of property you buy.
It is also important to consider how much you can afford month-to-month. ‘Serviceability’ is all about how much you can afford to allocate to repaying the loan each month. Rental income will be considered by your lender, but it varies between different providers. Some will allow 75% of the repayments to be covered by rental income, others up to 80%.
The lender will then need to be satisfied that your income can cover the remainder of the repayments. Remember, there could be costs other than the loan, such as strata fees, council rates or repairs, and you need a buffer for these.
Deciding on the right structure is also critical. Owning a property in your name is only one option. Depending on your situation, there may be benefits to owning through a different structure, such as company, trust or SMSF. Each one will have its pros and cons, and its own tax implications. An accountant can advise you on this.
TR - As an investor, I would also be thinking of of ways to maximise my valuation prior to refinancing the loans so I could really boost my borrowing power. There are a number of key factors that come into consideration when the bank is determining a property’s valuation. Everything from comparable sales to location data to the physical condition of the property (inside & out). Many of these factors are out of your control as an investor, but the one that can be controlled is the condition of your property. Is it worth doing a cosmetic update before refinancing?
MD - As you say, valuations are mostly based on recent sales of similar properties within that particular area. But just as important, is the condition of the home. Many of our clients have renovated in order to increase the value of their property. This has in turn, allowed our clients to access more equity than before, even after the cost of the renovation has been accounted for.
It's important to note, that it is possible, (based on your area and the cost of the works that are planned) to over-capitalise (ie, not increase the value of the home more than the cost of the renovations). To avoid this, it is best to engage the appropriate experts.
TR - Given the lending space at the moment what advice can you give to investors at the moment?
MD - My advice here would be to talk to a professional. A good mortgage broker is your best friend, especially when you’re starting out or accessing equity for the first time. They’ll help you understand how much you can borrow and the types of loans available. It’s a lot more detailed than simply plugging your numbers into a home loan calculator! And your broker can answer a whole range of questions, because they’ve done it all before for hundreds, if not thousands, of clients, using many different lenders.
Alongside the broker you’ll also benefit from working with experts like:
an accountant, to advise on tax and structure;
your property manager, to provide insights on the market, rents and returns
a depreciation specialist, to assess what losses you can claim for tax
a conveyancer, to manage the legal affairs and contracts
a building inspector, to make sure you don’t buy a dud!
Should you need some assistance with accessing equity contact us below to chat with Managed & Matt. Managed also has a number of articles on refinancing, home buying and renovating your property. Head to our blog to find out more.