Unlocking your Home Equity

Are you a member of the Equity Rich, Cash Poor Club? Discover how you can use your real estate property to free up money. By Senlitonga for the March edition of the API Magazine Australia where you will find useful information about real estate investing and tips to success.

What are our options for unlocking home equity?

Question: We own our home and are looking to unlock the equity in the cheapest way, in terms of interest rates, application and ongoing fees. The home is worth $350,000 and we would need about $100,000 in the short term. What would you recommend?

Answer: You have a few options to release the equity in your real estate property. First up, although you’ve paid off the property, check that the title has been released by your previous lender. This will decrease the fee you pay when you register the title with another bank lender. One option worth considering is a revolving line of credit. If you’re familiar with this loan type, it can be basically described as an overdraft account which is secured against your home property.

The word “revolving” means there’s no contribution required to your principal, as there’s no set term. You do, however, need to cover interest expenses. Some bank lenders allow interest to be capitalised into the bank loan. This means no repayments are required if you’re still under the borrowing limit. Another option in your case is choosing a “normal” mortgage, whether basic variable, standard variable or fixed interest. This avenue is likely to cost more since most of these loans enforce an “early repayment penalty” for the first three years.

Offset Explained in Real Estate Investing

Question: What’s the difference between a transaction account which reduces interest and an offset account?

Answer: In a nutshell, most offset accounts are transaction accounts but not all transaction accounts are offset accounts. Clear as mud? To get it into perspective, you need to understand the way an offset account works. It’s a way of shrinking your home loan by linking with your transaction account, the idea that every dollar in your transaction account is offset against your home loan. There are two types of offset accounts: 100 per cent offset and partial offset.

A 100 per cent offset account will reduce the full interest charged on the home loan by the amount you have in your transaction account. For example, if you have a $250,000 loan and you have $10,000 in your transaction account, you’ll only pay interest on $240,000.

Partial offset, on the other hand, means you receive a fixed amount of interest abased on your balance in this account. For Example, you might receive 5 per cent interest on a $10,000 you have in the account. That interest then goes straight into your home loan debt without incurring the income tax owed on the interest which would happen if the money was in the normal savings account.

Obviously an ordinary transaction account that isn’t linked to your home real estate loan is of no benefit in reducing that loan but the costs versus the benefits of a standard home loan, 100 per cent offset loan and partial offset loan have to be weighed up before making a decision.

A pitfall CANNEX has identified is the ineffective use many people make of offset accounts. To generate net benefits with a loan of $250,000, borrowers need to maintain a savings account balance of $12,000. This is to compensate for the 0.6 per cent extra an offset loan will cost compared to a loan without offset facility. Of 6000 offset accounts CANNEX surveyed, 63 per cent had a balance of $5,000 or less. These borrowers for real estate aren’t making the expected inroads into their loans and may have been better off in the long run with a standard mortgage.

Assessing the Capital Growth of your Real Estate Investment

Written by Monique Wakelin for the ‘Take Control: How Home Equity puts you in the driver’s seat’ article published in API magazine – December 2006 issue and this features the third part of this useful article.

Investors often ask how to measure the growth in the equity they control and how to access the capital growth achieved. Firstly, find out how much your property is worth on today’s real estate market, and you can calculate the increase on the original purchase price.

A simple model is to look at a real estate property purchased for $200,000 that’s now worth $240,000. The property investment has had a capital gain of $40,000 or 20 per cent.

Another method is to establish the rate of return on equity or the percentage by which your home equity has increased beyond the cash amount that was initially put into the property real estate investment. In the case of the $200,000 property there would have been a 10 per cent deposit of $20,000. If the property shows capital growth of 10 per cent in the first year, then there’s a $20,000 return on that equity or 100 per cent. This real estate capital growth will compound in subsequent years as seen in the following table at the end of this part of the article.

To suggest this specific level of home equity growth will happen every year is unrealistic. This is where the long-term view comes into play because of the wide range of factors that we know are going to affect real estate property. These are the “real life” situations ranging from rising interest rates to general national and state based economic conditions to changes in rental levels. Property real estate moves in cycles with periods of upturn and downturn and more stable, even price flows. Focused and disciplined investors in real estate pay little attention to the “bad news” and realise that their investment in real estate will increase exponentially as future property cycles move through upturn phases. Time evens out the highs and lows – as long as you get your asset selection right.

First time real estate home investors need to realise the first year or two of holding property will be the most challenging. It requires the mindset that there will be “glitches” until they see the pattern beginning to emerge. At this stage, they should also be exploring the options that provide some buffers against occurrences such as interest rate rises. For example, fixing all or part of their loan when rates are low can be a good insurance policy.

Return on Equity in home investments
This table outlines the return of an investment property purchased for $200,000 with an initial deposit of $20,000 and showing average compound annual growth of 10 per cent.

Year Capital Value Return(s) Return on Initial Equity (%)
Year 1 $220,000 $20,000 100%
Year 2 $242,000 $42,000 210%
Year 3 $266,200 $66,200 331%
Year 4 $292,820 $92,820 464%
Year 5 $322,102 $122,102 611%
Year 7 $389,743 $189,743 949%
Year 10 $518,748 $318,748 1,594%
Year 15 $835,449 $635,449 3,177%
Year 20 $1,345,498 $1,145,498 5,727%

For some more real estate resources on pre-construction condos and Whistler real estate and condo developments, click here.

Take Control: How Home Equity puts you in the driver’s seat

Real Estate Capital Growth is the sure-fire route to financial freedom through real estate property writes Monique Wakelin, but it all comes down to choosing the right assets. Part 1 published in the API magazine December 2006 issue.

If a potential real estate investor were to ask what the single most important factor was when selecting residential real estate there could be only one answer – a home property’s potential for excellent long-term capital growth.

The consistent and compounding effect of real estate capital growth is the golden goose because compounding growth produces equity in your real estate assets. It’s the ability to control more and more equity that can produce an income – the key to financial independence. Not only does capital growth, over time, provide the leverage for further investments, whether it be real estate or other, it’s locked away tax-free for as long as you own the property. Understanding the whys and wherefores of home equity and real estate capital growth are crucial if a prospective investor is to achieve the ultimate aim – financial independence through real estate investments.

Many residential property investors take the view that this asset class should be income driven. However, a higher growth property will actually deliver the better income stream over time. It’s more a question of balancing the growth potential and achieving a steady rental income rather than looking for high rental returns at the expense of the growth of the real estate investment property. During the actual years of the investment strategy, the role of rental income is to meet holding costs such as loan repayments, maintenance, insurances, rates and other outgoings.

Choosing high growth property real estate allows the investor to build equity quickly, which means they don’t need to rely on saving for another deposit from after-tax income. Compounding capital growth produces an exponential increase in value over time. If, for example, you buy a $300,000 investment property real estate that increases by an average of 10 per cent a year, then the compounding factor doubles its value every seven years, and you’ll create $1.9 million in equity over 21 years.

There can’t be too much emphasis on the fact that residential real estate property investment is a slow path to financial security and not a “get rich quick” scheme. It must be based on correct asset selection to produce consistent capital growth. But time and again, we see real estate investors making the same basic mistake, hinging on the belief that all property is good real estate property and that it must at some point increase in value. Instead, real estate investors end up with a capital loss or price stagnation and no equity to show for the years of repaying loans and funding maintenance expenses.

Only correct and specific real estate asset selection will ride out any property cycle downturns and even out the returns. Provided you’re at least five to ten years away from retirement, focusing on capital growth of real estate will allow you to accumulate some serious net home equity and built on it relatively quickly.

If we take a specific example of a well-selected property investment bought in 1980 for about $50,000 and look at its current estimated value we start to get the picture. In today’s market real estate, its value would be around $500,000. Back in 1980 that amount of money would have bought a house in the top-drawer areas of most major capital cities.

We know that over the past 26 years a number of major economic, real estate investment and political cycles have transpired and real estate property values have increased strongly in spite of booms and recessions. Anyone can purchase a real estate property that looks like it might perform well but the real aim is to purchase the ones that perform no matter the prevailing market conditions.

At its simplest level, capital growth on a property increases your equity or net worth. In other words, it’s what you actually own rather than what you owe. Good capital growth will increase equity at a faster rate than an individual could achieve simply through loan repayments or by saving cash in after-tax dollars. Top-performing residential investment property doubles in value every seven to ten years and grows in capital value by an average of 5 to 8 per cent a year ahead of prevailing inflation.

The scenario of applying for a bank loan gives us a good snapshot of how home equity in real estate is viewed from a purely financial perspective. Lenders seek security on their home loans and number one on the list is property. The highest loan to value ratio (LVR) is given against real estate property. Lenders will offer up to 100 per cent (or even more) of the purchase price against real estate properties, whereas shares will attract a maximum LVR of 80 per cent if you’re lucky.

Therefore, the higher the rate of capital growth on the home property, the greater the owner’s ability to use the accumulating equity to purchase further income-producing real estate assets. A real estate property that returns low capital growth rates makes the owner much more reliant on having to actively reduce the debt in order to create more equity. This can only be done through extra repayments off the principal mortgage out of after-tax wages or by paying off lump sums when funds become available. Home equity in real estate build-up from properly selected property will outstrip the rate at which most people can find extra dollars regularly from their own pocket.

For more information, please visit the API Magazine website or Urban Living tips and checklists for condominium living here.

Bricks and Mortar Real Estate Investment Tips

Welcome to another instalment of Bricks & Mortar, where our panel of experts answers real estate property investment questions from API readers. Published in the December Australian Property Investor real estate magazine.

When to sell real estate?

Question: My husband and I are both working at the moment, however, I’m going to be starting 12 months’ maternity leave in January. We think we might need to sell one of our investment real estate properties (we have six) to help ease the financial load during this time. My question is, from a CGT perspective, would we be better off selling the property while we’re both earning an income or should we do it when I’m at home with the baby? The property is in both our names, 50/50.

Answer: Congratulations on your pregnancy. I hope everything goes smoothly for you. From a CGT perspective, it’s best to wait and sign the contracts in a financial year where you have a lower income so that any gains made on the sale of a property are added to a lower base income and not a higher base income. By the way, and for what it’s worth, another option instead of selling an investment real estate property is to use a line of credit (LOC) to help with the cash flow. This LOC will mean that your debt will increase over this time but twhere the funds are used to pay for property-related expenses and mortgage repayments, the interest should still be tax deductible.

This real estate investment strategy enables people to keep their properties at times like this instead of triggering the enormous costs of selling and seeing their portfolio decrease, and allos them to keep all future gains in real estate value on the properties in question.

Dale Gatherum-Goss

Can I claim the interest on a real estate investment property

Question: I have an investment property in real estate with about $68,000 left on the loan. Long story short, the interest I currently incur isn’t deductible against income against the property. If I were to “refinance” this real estate property loan as part of opening a new loan which I require for the explicit purposes of buying another investment property, will the interest earned on the sum total of the loan (i.e. the $68,000 plus the amount of the new property) now be deductible against income from the new and/or both properties?

Answer: No unfortunately the Tax Office follows the money in cases like this to see the purpose of the new home loan and how the funds were used. So, any new house loan would be apportioned between tax-deductible debt and non-tax-deductible debt I’m afraid.

Dale Gatherum-Goss

Is it too late to invest in real estate?

Question: I am a 53 year old nurse who works full-time and I’m concerned my superannuation won’t provide me with enough money to enjoy my retirement years. I currently earn $55,000 per annum and have almost paid off my home which is worth about $300,000. My question is, is it too late for me to invest in real estate or property to help secure my financial future? If it isn’t too late, what should my real estate strategy be going forward?

Answer: No, it’s not too late. Yours is a common scenario where an individual realises that relying on superannuation alone isn’t going to deliver the retirement lifestyle they were hoping for. Provided you are five to ten years away from retirement, you can still capitalise on your income and home equity in your existing real estate property to build wealth.

To maximise that wealth creation through real estate property investment at this point in your life will require a very unemotional and businesslike approach in order to maximise your capital gains. Your selection of the right real estate property asset is crucial and you should be concentrating on only one area – the high-growth inner urban areas 2 to 12 km from a major CBD – where scarcity value, high demand and low supply will underpin your real estate investment. By focusing your property strategy on capital growth you will build and control home equity. And it’s controlling equity that’s the key to attaining financial independence.

Don’t be daunted by the higher prices in these areas. One very well chosen, more modest real estate asset – such as an apartment – can outperform the wider marketplace and inflation, not to mention larger, lower growth properties in middle to outer suburbs. Seek independent financial advice on the best loan package for your circumstances.

Next, seek truly independent real estate property investment advice to ensure you do get the maximum capital gain and good, long-term rental income. These two advisory areas should be kept separate. Don’t waste any time before seeking the appropriate advice. Steer totally clear of any “get rich quick” property real estate investment schemes. Many people seeking to rapidly top up inadequate superannuation have been tempted by these to their financial detriment.

The safest way to invest in this real estate asset class ist o take an unemotional, longer-term very well advised view.

Monique Wakelin

Real Estate Valuation discrepancy

Question: Why is there such a big difference between a real estate agent’s appraisal and a valuer’s valuation of a property or home, particularly when it’s for the bank? I had an agent give me an assessment of the value of my home before getting my loan but the bank valuer said it was worth a lot less.

Answer: It probably comes down to a question of the instructions and motivations of the valuer and the real estate agent. The valuer is instructed by the lenders to provide a realistic assessment of the real estate market value of the property as they find it on the day of inspection. They can’t take into account future improvements or presentation issues you may attend to if you were to place it on the real estate market. The lenders simply want to know a “safe” amount they should use as security, so in the unlikely event they have to take over the property, they’re covered.

The real estate agent’s appraisal isn’t bound by these instructions. Often the reason for providing a free appraisal is as a marketing tool to try to gain your favour and ultimately a listing. Therefore, it’s in their best interests to be “bullish” about their opinion of the market value so that you’re more positive and inclined to list it with them. Remember that real estate valuers are totally independent and have no vested interest in your real estate property or home.

Phil Grahame