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HOW LEVERAGING YOUR EQUITY WORKS AND A STRATEGY TO ACCUMULATE WEALTH

HOW LEVERAGING YOUR EQUITY WORKS  AND A STRATEGY TO ACCUMULATE WEALTH

Simply, equity is the difference between the value of your home and how much you owe the bank against it. So if your home is worth $800,000 and you owe $500,000, you have $300,000 in equity, ($800,000 – $500,000 = $300,000). You can use this equity as security with the bank and borrow against it to put as a deposit for the purchase of your next investment property. However, you can’t use 100% of your equity. Banks will typically lend around 80% against the equity. So in our example let’s look at how this works where the bank will lend 80% against your equity.

  • Value of your property x 80%; ($800,000 x 0.8 = $640,000)
  • Less your debt of $500,000; ($640,000 – $500,000 = $140,000 of useable equity)
  • This $140,000 is totally available to you for your use as a line of credit.

Use this amount to purchase your next investment property. Generally you will require a 10%  deposit (check deposit amount with lender) + mortgage insurance (if less than 20% deposit) + stamp duty costs + conveyancing/legal fees + building and pest reports.

Take my property recommendations, inspect the properties you are interested in, carry out your due diligence (more on that below) negotiate the price with the agent & purchase the property (more on that below). For auction properties I will recommend a purchase price guide based on investment principles.

RINSE – RECYCLE – REPEAT

BUY & HOLD LONG TERM…….That’s your strategy

With this strategy, eventually you get to the point (the aim is within 5 – 10 years of your 1st investment) whereby your ever increasing pool of equity from which you can readily use pays for all expenses and provides you with the amazing lifestyle that you dream of….financial freedom!! Alternatively. if you want to reduce your LVR (loan to value ratio) to live off your positive geared rental income, then you have that choice as well.

Aim to purchase at least 3 recommended properties in the first 5-6 years.

your 1st property in year1

your 2nd property in year 3

your 3rd property in year 5-6.

On average your properties should double in value between 7-10 years if they are quality properties with the right criteria. It is very possible and realistic to acquire  3 – 5 properties in 10 years.

I suggest that you consider taking out interest only loan repayments. This way your interest repayments will be lower than a principal + interest loan greatly assisting your loan serviceability requirements as well as assisting your cash flow. Our principal aim is not to pay down the debt of the investment properties during the property accumulation phase, but to buy properties for their good capital growth potential.

Now let’s see how this works:

  • Year 1 say you purchase your property for $450,000.

By year 7- 10, this should be worth around $900,000

Tap into your equity at your first opportunity for the deposit to purchase your 2nd investment property as well as having enough for renovation costs if applicable & a safety buffer. Go for 80% LVR

  • Year 3 say you purchase your property for $1,000,000

By year 7-10, this should be worth around $2,000,000

Tap into your equity at the first opportunity for the deposit to purchase your 3rd investment property as well as having enough for renovation costs if applicable & a safety buffer. Go for 80% LVR

  • Year 5 say you purchase your property for $1,500,000

By year 7-10, this should be worth around $3,000,000

  • Total purchase price = 2.95 million dollars 
  • Total market value of investments after their 7-10 year cycle = 5.9 million dollars
  • Total gross money made = 5.9million – 2.95million = 2.95 million less your deposits paid

 Where else could you make 2.95 million dollars (gross) in 10 years???…& while you were sleeping!!!

Now you can tap into your equity for any property anytime you want so you can purchase the next property, but for this exercise, let’s use the 3 properties together after their 7-10 year cycle.

  • Bank will lend 80% x 5.9 million = $4.72 million

Less what you owe, so $4.72 million – $2.95 million = $1.77 million

  • You now have $1.77 million as a line of credit at your disposal to use as you wish!!

Your holding costs will be around $80,000 per year (which is tax deductible with negative gearing). This holding cost for the year may sound like a great deal of money, however if you think about it from another angle, your equity is increasing at approximately an additional $300,000 per year!!! That’s every year!! Add to this the compound growth which is working for you. This is growth on the growth. This is calculated at a general 7% annual growth. So all your running costs are covered by your ever increasing equity that you can continually tap into and with the remainder you can live your financially free lifestyle.

This holding cost (or negative cash flow) of around $80,000 is negatively geared, meaning you can offset this amount from your tax bill.  You basically get the money that is negatively cash flow back. However, you still need to be able to have the money to pay for this until the end of the financial year.

At this stage you can choose to work or not. Your assets & wealth will continue to grow automatically and at a rate higher than inflation.

Don’t be fearful, as the overall value of your properties should always be substantially larger than your line of credit and loans. The properties must always have a maximum LVR of 80%. LVR is the level of debt to market value of the property. Strictly stick to an LVR of 70% – 80% maximum. Now whenever you want, you can sell any of your properties you desire and walk away with your profit. This would also reduce your LVL ratio so you could potentially be living off the sale profits as well as potentially positively geared property.

Let’s use a 10 year cycle as an example. After approximately 10 years, you will have many options depending on your goals:

  • You can sell a property with high equity and pay off the mortgage on your principal place of residence which will have also amassed considerable equity over the years.
  • You could also pay off the mortgage on your principal place of residence by refinancing another property.
  • You could sell a property or properties to reduce the LVR of your loans & live off the equity from the remaining properties (which increase annually) as well as the rental incomes (if this is the case depending on your combined LVR being low enough to make your properties positively geared)
  • Depending on the ultimate income you would like to retire on you could continue on your path of purchasing further investment properties using the same strategy

Note that to be able to continually tap into property equity the bank/lender will always want to see payslips. So amongst other criteria, work out your strategy and what type of properties and loans you want to have based on loan serviceabilty and being able to refinance properties to tap into equity and then borrowing for further property purchases.

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