How to use your equity

Written by view.com.au in Buying

A hand with coins in it

When deciding whether or not to use your equity, the best thing to do is measure how the various options weigh up against your financial position. Will you use your equity to renovate your existing home, buy an investment property or diversify your assets through stocks and other investments (i.e. a business)? Once you weigh up the feasibility, risks and benefits of these options, you can then gauge whether or not you should take the next steps to borrow on your equity. What are the risks of borrowing on your equity? A financial advisor will be able to highlight what risks apply to your financial situation (i.e. whether you have a healthy balance of income vs. capital), but your cash flow and the state of the market are two major influences that can affect your ability to refinance using your equity.

Renovating your home

The main reason why you would choose to dedicate capital gains made towards renovating your home is to compound the value of your investment (your home), create further value to your home (for an upcoming sale) and to build wealth in the long term without being susceptible to the current state of the market.

Keeping your wealth within the home may make it easier for you to manage your finances and enjoy the benefits of compounding the capital gains made on your home in a time where the market may not be on your side.

Creating quick value to your home does depend on the nature of your renovations. Bathroom and kitchen renovations, as well as costmetic and minor updates to your home, can create immediate value to your home prior to you selling, but remember that the value you add gradually diminishes as those renovations age.

Building wealth in the long term through renovating usually involves larger renovation types (additional levels, extra rooms, landscaping, roof replacement or entire home renovations). This has the opportunity to open your home to buyers with larger budgets.

Buying an investment property

It is common to borrow on existing equity to finance an investment property. This may become harder in times when lenders tighten their belts and especially when the market shows signs of significant falls, yet it is still seen as the most feasible way to develop enough capital to invest in a property while still paying your initial mortgage.

Using equity to invest in a second property comes with its pros and cons but the risks can be mitigated as long as you are aware of them and have a strong financial plan behind your investment. For instance, using equity to finance an investment property is one of the most common ways to accelerate the compounding of your wealth, but this comes with a significant risk of restricting your cash flow. You need to be aware of this and budget for it before trying to refinance. Understanding how your cash flow will be affected requires looking at the details of your budget, down to the nitty-gritty, and having a full understanding of the associated costs of investment properties.

If you do go down this road, make sure you approach it with the same level of research and caution you did with your first home. You are not investing in a home, but in a business, which means it can be a great idea to mock up a ‘business case’ for your investment, setting out your financial position, the state of the market, your expectations for growth and how you will approach the management of your investment (i.e. business). Looking at it this way will add extra weight to your decisions and even keep you from overextending yourself when it comes to purchasing an investment property.

Diversify your assets with your equity

One main advantage of using your equity to invest in stocks or other asset classes (such as a business) is that you don’t have to leverage so much of your equity but choose a smaller proportion on which to refinance. The other advantages lie in diversifying your asset base so as to include more liquid assets (such as stocks) rather than keeping all of your money tied up in your super and a home (which you can’t rely on to sell quickly if you suddenly need extra money in times of financial stress).

One way to still invest in property with equity but maintain the liquidity of your asset is to buy with friends or family. There are of course things you need to consider when buying a home with family or friends, but it may be easier for you to liquify your share of the property if it is split between more investors who also agree (within a contract) to collectively buy you out if you demonstrate a significant or urgent need for the equity held in your share.