The pros and cons of using your home equity to invest in property
In my last article, I discussed why you need a large deposit for residential investment property, and how a larger deposit doesn’t make investing in property any less attractive. A popular source of deposit capital is the equity in an investor’s home (the difference between value and mortgage outstanding). In this article, you’ll learn the pros and cons of using your home equity to invest in property.
Is your wealth underperforming?
Research by Halifax in November 2017 concluded that the value of the UK’s housing stock is more than £6 trillion. Even more impressive is that the average homeowner in London has equity of £360,000. In the North West, average home equity is more than £134,000.
Most people don’t think about the equity in their home as potential investment capital. For sure, it’s performing better than cash in the bank, but is it working as hard as it could for you?
Let’s say that your property’s value grew by 4% last year and that you have £100,000 equity in it. Effectively, your equity made you £4,000. Property investors who put £100,000 down as a deposit on a property might expect a return of three, four, or even five times this amount, thanks to the benefits of leveraging.
Other benefits of using home equity to fund property investment
There are other benefits of using the equity in your home to fund an investment in residential property.
You could build wealth faster
By using your home’s equity as a deposit on an investment property and funding the balance with a buy-to-let mortgage, you could increase your personal wealth faster. You get to make money on other people’s money. You also benefit from the rental income. Combined, this could provide a return on investment of 10% or more every year. That’s way better than leaving it in your home.
Your returns increase with house price inflation
Let’s take that £100,000 home equity. Let’s say you use it as a deposit on a £300,000 property. If you left it as equity in your own home and its value increased by 5%, it will increase your wealth by £5,000.
A 5% increase in the value of your investment property increases your wealth by £15,000. Plus, of course, you still benefit from the increase in the value of your own home.
Now, let’s say that next year property values also increase by 5%:
The equity in your own home would have increased by £5,000. That would produce total growth on your unused equity of £5,250 in year two.
The value of the investment property would now increase from £315,000 to £330,750. An increase in the second year of £15,750.
Over two years, leaving the equity in your home in this scenario would provide capital growth on that equity of £10,250. Investing it into the residential property in our example would produce capital growth of £30,750.
Recycle your wealth to pay off your home loan faster, or improve your lifestyle
What do you do with this extra wealth? How about paying off your home loan faster?
UK property prices have, on average, doubled every 8 to 10 years over the long term. That’s an average growth rate of about 7.25% per year. Being conservative, an average growth rate of 5% per year over 10 years would increase a property’s value by approximately 63%.
That £300,000 investment property you bought would be worth £489,000. That’s a profit of £189,000 on your investment capital of £100,000. A 189% return. Put another way, more than 11% average return per year on your investment.
You could recycle this wealth to pay off your home equity loan earlier. Or to improve your lifestyle. Send your kids or grandchildren to the best schools. Take a few well-deserved holidays. Cut down on the time you spend at work. What you decide to do with any wealth you build is your decision.
So, gearing, wealth building, and lifestyle improvement. All of the equity in your home.
The risk of using the equity in your home to invest in property
When you take equity from your home to invest, your borrowings increase. You’ll need to consider your ability to keep up repayments on your mortgage before investing. This is where the rental income from your investment comes into play.
There are several ways to mitigate this risk. For example:
- Buy residential investment property in the best location
- Ensure that your property appeals to the widest audience
- Always buy property at a discount to market value
- Conduct due diligence and accurately project cash flows before you invest
Have you got dead money tied up in your home? Contact Gladfish today on +44 207 923 6100 and book a strategy consultation. Together, we’ll assess your current financial position and investigate how the equity in your home could bring your lifestyle dreams closer, sooner.
Live with passion and fun,
Brett Alegre-Wood
