Just bought your first home? Congratulations, you have made it inside the club. The line was ridiculous and that bouncer…rude. But forget that, you are a homeowner and from here on in it’s champagne and – wait. What is that second door with another bouncer in front of it? It has its own line! There seems to be a small sign above the door… “property investors only.” Oh, come on!? Ok well, how do you get in then? Well, try investing using your current house.
Option 1: turn your existing home into an investment property
This means shipping up and shipping out! There are some great advantages to turning your first home into an investment property. However, there are some things you need to be aware of.
- More than anything, you need to be sure that you can afford this move. If buying your first home was a huge stretch and you are only just making those mortgage payments, will it be impossible to pay rent or mortgage payments on a second residence while you rent out your first home?
- Do the sums. If you buy a second property, will your repayments (and purchase costs) to this new property exceed your incomings from your original home, which is now acting as your investment property? Say your rental income from your first home is $18,000 but you have to pay tax on your gains for the year, as well as any remaining mortgage costs and management fees etc., does this net income cover the costs of a second home you may have purchased? If the answer is no, then perhaps it is a better idea to take option 2 below: sell your first home and use the equity you have made to purchase. Alternatively, explore the option of negative gearing to offset this shortfall.
- Be sure of what your rental income will be if you turn your home into an investment property. This will help you ascertain what effect this will have on your cash flow.
- Will you buy a second property or rent a second property? How will either choice affect your yearly outgoings?
- Be aware of Capital Gains Tax exemptions. Currently, if you live in your property for the first 12 months immediately after purchase, you can then rent this property out for a maximum of six years and then sell it without paying tax on your capital gains. This can be a great incentive to turn your existing home into an investment property. If you think your outgoings will exceed the income you make from your investment property, remember that you can negatively gear the tax you expect to pay on your investment property.
Option 2: investing in a second property
If you don’t want to use your first home as an investment property, you can use it to build equity and buy a second property.
What is equity? A home has a market value. This (hopefully) grows each year. This is called capital growth. Equity is the difference between your home’s market value and what you currently owe on your mortgage. However, you cannot use all this equity when reinvesting. Your lender will take into account a number of factors before allowing you to leverage your equity.
What is leveraging equity? If you take out a mortgage worth 80% of a property’s market value, and then the property increases in value over a number of years, your mortgage will be a smaller percentage of the new market value. You can then refinance, increasing your loan back up to 80% of the new market value. This creates usable equity in the form of cash, which you can reinvest in the deposit of a second property.
When using equity against the balance of a new loan, consider the following:
- Can you afford to pay more than one mortgages if you use equity to purchase an investment property?
- Do more research than you think is necessary. When it comes to one of the biggest financial decisions of your life, you don’t want to make it lightly. Become an expert on investing. Then become an expert on tax law. And then finally, become an expert on the area you wish to invest in.
- Is there a better use for the cash you open up from usable equity? Remember the old adage of not putting all your eggs in one basket isn’t as famous as it is for no reason. Diversification of investments is the safest and smartest way to guard against any fluctuations in different markets, whether they be property or stock markets.