How To Use Equity To Buy A Second Property
If you own a property, you can use that property to raise money when you need it.
Whether you want to finance your children’s university education, pay off your debts, renovate your home, buy a second property, go on your dream vacation or require money for some other purpose, you can use the equity from your current property to meet your money requirements.
What does equity mean?
If you buy a property with a mortgage, the value of the property minus the money you owe on the loan is considered to be your equity in the property.
In other words, it is your share of the property. Of course, if you have bought the property without borrowing any money from a lender or have paid off the loan, the entire value of the property is your equity.
How does equity work?
We can understand better how equity works through this simple example.
Suppose you bought a house valued at £250k and took a £200k mortgage loan from the lender for making this purchase.
Your equity in that property is considered to be £50k. Now, over some time, via monthly instalments, you repay £30k. At this point, your equity will become £80k.
This, of course, is the case if your property is still valued at £250k. However, if the value of your property has increased and is now £265k, and you have repaid £30k, then your home equity would become £95k.
Basically, it is calculated as your property’s current value minus what you owe on it: £265k minus £170, which is £95k.
If you have no mortgage on the property, then the current value, whether it is £250k or £265k, is considered as your home equity.
What is negative equity?
Of course, in some rare instances, it is also possible that you have a mortgage on your property, and its value has depreciated to such an extent that you have negative equity.
For example, you bought a house valued at £250k with a £220k mortgage loan from the bank.
Over a few months, you have repaid £5k on the mortgage.
However, during this time, the property rates in your town or city have depreciated, bringing down the value of your property to £210k. In this instance, you will have negative equity of £5k because you owe £215k while the value of your home is £210k.
To put it simply, what you owe is more than the current value of your property. Therefore you are in negative equity.
Why should you use your equity?
You must’ve often heard it is wise to invest in property. And, no doubt you considered all the pros and cons before deciding to buy your first property.
Nonetheless, unless you are leveraging your property to create assets and build wealth, you are not really making the most of it as an investment.
If you live in the house you bought through a mortgage, you would be paying instalments to repay the loan.
Even if you purchased your home without taking any loans — its upkeep, utility bills, must be costing you money. You are still not really seeing any returns on the money you invested in your property in both scenarios. If anything, your home acts as a liability for you at this stage.
But by releasing equity, you can turn this around at an opportune time to buy your second property.
Then, with a buy-to-let, you can finally use the property as an investment to generate rental income.
Buying A Second Home
You may have various reasons for buying another property. This could be your second home, a holiday home for your family, or a holiday rental that you let to people for a short time.
One of the most simple & lucrative uses of the equity, though, would be if you buy-to-let as that would allow you to earn a steady income, not to mention the capital growth you will benefit from as the value of both your properties appreciates.
Remortgaging to buy-to-let
Now that you’ve decided to consider buying a second property, you should do the math to see if remortgaging your current property can help you raise the equity to buy another property.
First, you will need to determine whether the equity release will cover your buy-to-let’s deposit amount.
Assuming that the equity you receive through the remortgage of your first property will suffice as the deposit amount for the loan you take against your second home.
However, might not be enough to cover the entire cost of the buy-to-let. When purchasing a second property you have to budget for additional stamp duty and extra costs.
Still, the more equity you have, the bigger the deposit you can make. This will bring your loan to value ratio down significantly on the second property, enabling you to benefit from a lower interest rate on the second mortgage.
What is loan to value, and how does it work?
Loan to value (LTV) is the total loan amount extended to you against the value of the property you intend to buy.
So, if we use the earlier example, suppose you bought a house valued at £250k and received a £200k mortgage loan from the lender and made a deposit of £50k for purchase the property, your LTV would be 80%.
In other words your you have received 80% of the property value as a loan from the lender, and the remaining 20% – your deposit – is your home equity.
Now, in most cases, lenders charge a higher interest rate for a higher LTV percentage.
So, for example, if your LTV were 90% instead of 80%, you would be more than likely to pay a higher interest rate.
How does remortgaging for equity release work?
When you remortgage to release cash, other than re-evaluating your current property value for calculating your equity, lenders will also review your creditworthiness just like they did the first time around when you bought your first house.
So, although this is a remortgage, you can expect to go through the entire loan application process once again.
Among other things, your lender will review your income, savings, credit history, expected rent, and the deposit payment you are looking to make to determine whether they should extend the loan to you and choose the mortgage rate suitable for you.
The good news, though, is that if you have been regular with your instalments on your existing mortgage, that would have helped improve your credit rating, improving your remortgage chances.
When you remortgage your property and take out another buy-to-let mortgage, you will also run into additional expenses other than the deposit amount. So, you need to take into account whether the equity you release will cover:
Early repayment fees (on the first mortgage)
Before you turn your equity into the cash you need for financing your buy-to-let purchase, you should establish what the second mortgage will cost you and whether you can afford it.
Most lenders require a deposit that is in the range of 25%+ of the property value in the case of a buy-to-let property. And the mortgage rates for a buy-to-let property are typically higher than a residential property.
In the case of a buy-to-let property, your lender will also take into account the rent you are expected to receive on the second property.
Alternatively, if you are thinking of moving into your second home and rent out your first home, you will need to inform your lender about your intentions.
Depending on your financial situation, your mortgage options, and how much equity you’ve built in your home, you can decide whether you are in a position to invest in a buy-to-let.
Our Recommendations before getting another property or a buy to let mortgage
Some quick points to consider for your buy-to-let:
- Does your equity meet your budget?
- Are you suitable for receiving credit?
- What is the loan to value for the remortgage?
- Does the remortgage interest rate work in your favour?
- Does the income tax you need to pay on the rental income make this a worthwhile endeavour for you?
If you have a poor credit history it will impact your mortgage offers. At Alexander Southwell we work with a range of specialist lenders who work with clients with bad credit and we will be able to help. For more information, read our range of articles on dealing with poor credit here.
Remember, time will help improve your credit rating, so be patient – three months can make a lot of difference.
Consult An Expert Before You Approach A Mortgage Lender
If you have built sufficient equity in your first property, no doubt, an excellent opportunity exists for you to use it as an investment in a buy-to-let.
There are many real estate considerations, financial calculations, loan eligibility criteria and property tax features that you need to be aware of to ensure that you are reaping maximum benefits from your release of equity.
For example, you need to know when it is a favourable time to invest in a second property.
Similarly, you need to know when the lender interest rates work to your advantage for refinancing your existing mortgage. And there are many such details you need to be well versed with to use your equity optimally to get an investment property.
So, it would be best to take expert advice from an expert mortgage broker to decide whether you should access your equity to buy a second property.
Since we specialise in this field, we can assist you with the planning, assessment, and other related matters to enable you to capitalise on the opportunity that your equity offers.