What Is Equity? (Lesson 5: Intro To Property Investing)
Equity is a term used a lot in property investing and it is really important when building a portfolio. But what is equity and why is it so important?
Equity is a term used a lot in property investing and it’s really important to understand it. Especially when you’re going from property number 1 and you want to jump in to number 2 or 3 or 4, etc. So, what is equity and how does it impact your property investment journey?
Hey, guys, I’m Ryan from onproperty.com.au and I help people find positive cash flow properties all over Australia. And you’re listening to lesson number 5 in our series on the Introduction to Property Investing.
So, what is equity? In short, equity is difference between the debt that you have on a property and how much that property is actually worth. So the easiest way is for me to actually show you this and let’s use an example. Let’s say you have a property that is worth $500,000. But, you have a $300,000 mortgage on that property. Well, you would have $200,000 in equity. You take the value, $500,000, take away the debt, in this case $300,000, and that leaves your equity of $200,000.
So, equity is the difference between the debt that you have on a property and how much that property is actually worth. Now, equity is only truly measured when a property is valued or when a property is sold. Although, investors love to do their own equity analysis all the time based on what they think their property is worth.
But really, when a property is sold, that really tells you how much equity you have. Because you get the cash, you pay off your loans and whatever you have left, that is how much equity you had in the property. Or, when you get a property valued, then you can borrow against that equity.
That’s a little bit different, so we’re going to talk about that in a second. I just want to let you know that I’m not a mortgage broker, so this should not be seen as mortgage advise. But, borrowing equity, as I said, is a little bit different. So, for the purpose of this video, I’m going to label this term, “borrowable equity”. I don’t know if that’s actually a term that people in the industry use, but I think it serves our purposes really well here.
So we’ll use the example when we sold our property. Let’s just pretend there’s no expenses in selling it, just to make our math really easy because it’s Friday as I’m recording this. So, if we have our $500,000 property and we sell it, we pay off our $300,000 debt. We have $200,000 left in our pocket. So that is selling it. But, when we borrow, it’s a little bit different.
Now, generally, to get an equity loan, or to borrow against the equity that you have in a property, you can generally only borrow up to 80% or a residential property’s value without incurring extra fees called “lender’s mortgage insurance”. This varies, so see your mortgage broker if you actually want to go ahead and do this.
Let’s use our example again. But, we can only borrow up to 80% of that property’s value, which is actually $400,000. So, we can borrow up to $400,000. We have $200,000 in equity, but we’re only allowed to borrow up to $400,000. And because we already have a $300,000 debt, that means we can only borrow $100,000. As you can see, our borrowable equity is only $100,000 even though we have $200,000 in actual equity.
The reason equity is so important is because saving a deposit is really, really hard. If you’ve purchased a first property, you would know how hard it is to save that deposit. And equity can be used to invest in future properties without having to save a deposit. So if you can borrow money against the equity in property number 1 – let’s use our previous example where we borrowed $100,000, you can then take that $100,000 and you can use that as a deposit on your next investment property so you don’t have to save a deposit.
This allows you to leverage or it allows you to jump from 1 property to 2 properties to 3 properties without actually having to save the deposit every single time.
So, equity is really, really important when it comes to moving forward and growing a sizable property portfolio. That’s why I thought it would be very important for you guys to understand what exactly equity is.
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