Something about equity I don't understand

Hi Guys,

So far in the books I have read, one of the main opinions is that using equity is the best way to purchase more properties more quickly.

I am a bit confused...whats the difference between drawing equity from say your PPOR and just getting another mortgage for 100%+costs of the purchase price of your next property.

You pay interest on the equity, and on the loan so whats the difference?

All I can see is that it means you don't have to save cash for a deposit, but are you not effectively borrowing 100% of the purchase price when you use equity to purchase a property? so why not just get a 100% loan (assuming you could?)

I just don't understand how having huge amounts of equity helps you when it seems to be the same as going out and getting another loan

Would be great if someone could clear it up for me!
 
There's a subtle difference. "Drawing equity" means increasing the loan on an existing security (PPOR or IP - say to bring it back up to 80% LVR) and using the newly available funds for whatever purpose.

One of those purposes could be to take the money to a different lender and use it as a 20% deposit on a new IP. This would enable you to have some lender diversification as all your affairs won't be in the control of one lender.

You could also take both securities (old and new) to your existing lender or a new lender and ask for a 100% + costs lend on the new place with the security of the equity you have in the current one, assuming your serviceability is OK. The best option depends on your circumstances but generally speaking it is a good idea to diversify your lenders, all other things being equal (which they never are eg you may not be able to borrow quite as much...).
 
We're building a house at the moment - with $4000 downpayment in cash. The remainder of the 40% deposit entirely from equity from other properties. If we didnt have the equity we'd have to save up that entire 40% cash.

The actual loan for the new house will still be 100%, just with such a high equity deposit we don't have to pay mortgage insurance etc etc.

If we didn't want to be so cross collateralised we'd draw the equity out of the other houses up to the 40% we need, and then only borrow 60% for the new house. We'd still owe the same in total but the loans on the older houses would be bigger and the new house would be smaller.

I swear the more houses and loans you have the messier things get ...
 
Borrowing above 80% LVR in most cases involves lenders mortgage insurance, which can be expensive.

In many (most) periods, borrowing 100% LVR just isn't possible. This is especially as your portfolio gets bigger.

In effect, there is no difference between using existing equity as deposits and borrowing 100%. In practice, sometimes borrowing 100% just can't be done.
Alex
 
Also, remember equity money is 100% tax free money whereas savings money can be after tax dollars. So saving 100K after tax will require you earn over 100K.

Cheers,
Oracle.
 
I find its not the equity that limits the investing but servicability and cashflow. You can have plenty of equity but unless your capitalising interest you need cashflow to make your equity work for you. This is assuming you are investing in -'ve geared property.

Cheers
Rick
 
So there must be a point where no matter how much equity you have you cannot purchase anymore properties as your cash flow is the limiting factor? I assume for most average wage earners this point is reached at 2 – 3 properties?

So what is the benefit of owning cash flow negative properties? Might get some tax deductions but at the end of the day its still costing you money. Yes you are gaining equity but you are not getting cashflow which means your equity is useless?
 
So there must be a point where no matter how much equity you have you cannot purchase anymore properties as your cash flow is the limiting factor? I assume for most average wage earners this point is reached at 2 – 3 properties?

Too many variables. Rent increases, interest rate changes, etc can all affect your cashflow. The lending environment affects how willing banks are to lend to you. There is no general rule to this.

So what is the benefit of owning cash flow negative properties? Might get some tax deductions but at the end of the day its still costing you money. Yes you are gaining equity but you are not getting cashflow which means your equity is useless?

Given the same capital growth, +ve cashflow is better than -ve cashflow. However, -ve cashflow can work as long as the capital gains justify it. You can still access equity, it's just at a lower and lower LVR as you become rent-reliant, etc.

Worst case, sell the property and buy bonds with it.

There is such a thing as thinking too much, Prep. Go buy a place and you'll see the numbers in action.
Alex
 
So there must be a point where no matter how much equity you have you cannot purchase anymore properties as your cash flow is the limiting factor? I assume for most average wage earners this point is reached at 2 – 3 properties?

So what is the benefit of owning cash flow negative properties? Might get some tax deductions but at the end of the day its still costing you money. Yes you are gaining equity but you are not getting cashflow which means your equity is useless?


As your rent increases so does your cashflow. Also, your wages should increase in line with inflation over time. This improves your serviceability. Once you have the serviceability you can use the increased equity as deposit for new purchases.

Alternatively, you can sell some properties with equity while keep some and pay down all the debt.

Having equity gives you lot's of options you just need to explore them.

Cheers,
Oracle.
 
thanks guys for explaining that.

I have purchased, but I just like to understand where im going and what im getting myself into

Cheers.
 
So there must be a point where no matter how much equity you have you cannot purchase anymore properties as your cash flow is the limiting factor? I assume for most average wage earners this point is reached at 2 – 3 properties?

Depends how good you are at purchasing. Obviously if you have CF+ properties you can afford more. As mentioned as rents go up so does your servicability.

So what is the benefit of owning cash flow negative properties? Might get some tax deductions but at the end of the day its still costing you money. Yes you are gaining equity but you are not getting cashflow which means your equity is useless?

The benefit is if they gain equity more than the outlay (that's the goal). Obviously there is a limit to the number of these you can buy though. It's not always easy to find CF+ properties but most people try to get as close as they can (well I do).
 
So there must be a point where no matter how much equity you have you cannot purchase anymore properties as your cash flow is the limiting factor? I assume for most average wage earners this point is reached at 2 – 3 properties?

So what is the benefit of owning cash flow negative properties? Might get some tax deductions but at the end of the day its still costing you money. Yes you are gaining equity but you are not getting cashflow which means your equity is useless?

Dont worry, if I could have bought these properties & rented them out at a c/f positive amount, I bloody well would have !
 
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