What's equity and what are your finance options

Property owners regularly talk about using equity to build a property portfolio, but how do you actually access it?

If you can come to terms with using equity to either start out in property investment or make up any negative cash flow applicable to your existing portfolio, how do you actually get hold of your equity?

First let’s talk about what ‘equity’ actually means from a lenders point of view as many borrowers mistakenly assume that 100 percent of their equity is usable when comes to buying another property.

Equity in real estate is the difference between your loan balance and the value of the property that loan is associated with. Lenders however have what is called ‘loan to value ratio’ (LVR) restrictions, depending on lender and your willingness to pay Lenders mortgage insurance premium (LMI) this can be up to 90 percent of the property value.

To put this in a simplistic example, if your property is worth $1M and you owe $500k against it, the equity you can realise on sale is $500k less the cost to sale. If you wanted to use the equity to buy another property without paying LMI, the usable equity is $300k (($1M x 0.8) - $500k)).

So, you see, from a lenders point of view, you don’t have as much useable equity as you think you do. Unless you’re actually doing a cash out refinance, the best way to look at equity is as virtual money sitting inside your property and the only way to get 100 percent of it is to sell that property.

What are your options when ‘refinancing or restructuring’ for equity release?  

Refinance with the same or new lender

Generally, borrowers refinance with the lender they have their mortgage with (this is often called an internal refinance or restructure by the lender) and establish a second loan account that’s associated with the new property by using the equity in the existing property and the new property itself as security.

This approach has some advantages. Your existing lender already has your loan conduct history and you only need to pay mortgage registration on the new property because they already have a charge over the existing property (assuming you can afford to borrow the additional money you seek of course).  

The disadvantages are, you still need to submit a loan application for the new loan, lender would possibly revalue the existing property using Automated Valuation Models (AVMs) instead of sending a qualified valuer to do an onsite valuation, giving you access to a much lower equity value. Also, unless you explicitly demand a better deal on your existing loan, you are not likely to be offered a new discount.

The alternative and smarter option is to use this opportunity to review how your lender compares with other mortgage lenders on the market. According to Australia’s competition regulator (ACCC), as of September 2019, customers with loans making P&I repayments were paying an average of 26 basis points less than customers with existing home loans.

The ACCC Home Loan Price Inquiry Interim Report also found, the longer a borrower stays with a lender, the worse off they become when compared to new home loan customers to the same bank. An example used by the report showed that a borrower who had been with a lender for 5 years could save up to $5000 per year in interest savings by refinancing to a new lender.

When you refinance with a new lender, they will see this as an external refinance from another lender and will most likely offer you the best interest rate discount as a way to acquire your business.

The down side of going to a new lender, you will need to pay mortgage registration and transfer cost on both properties plus the administration cost to leave the existing lender.

The good news is, the saving in interest from refinancing most likely covers any refinancing cost and if you happen to choose a lender with cash-back offer, you will get a cash injection on settlement.

There’s a negative and positive aspect to taking the approach of starting over with a new lender. On the downside, it can take a lot longer than an internal refinance.

The benefits, however out weight any downside. Refinance with a new lender, if you want to save money, increase your cashflow and pay down your none tax deductable home loan off quicker.