What Is Equity & How To Use Equity To Build Wealth

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What is equity? How does it work? What am I talking about? Why do you want? These are all questions that people will ask and they’re fundamentally important. So what is equity? I’ll give you a quick example. We buy a house for 400,000 and then over time this property increases in value. So let’s say it’s now worth 500,000. This gap here of a 100K is equity. So how do we build equity? We build it through this mechanism here, growth, which would be supply and demand. So the demand for a suburb is greater than the supply of stock in that suburb and that causes prices to go up. Or if we’re here, we start with 400,000 we can get this going down. And how do we do that? We do that by paying off our mortgage. And so reducing this 400,000 and let’s say we get it to 300,000 then creates more equity in our property.

So in this example their $400,000 property has now got 200,000 in equity through growth in the market and paying down our home loan. So how can we accelerate that and what are we doing with this? So if we want to accelerate it we either need to find a fantastic growth market and what would we be looking for? We’re looking for suburbs that are in demand, but we’re also looking for cities that are in demand. So Melbourne’s a great example. It’s forecast to be the biggest capital city in Australia by the mid 2020s. It’s going to surpass Sydney. So what does that mean? It means people are migrating to Melbourne so that means the prices of property in Melbourne are going to go up because they’re not going to be able to build as fast as what the supply demands. For investors that’s great news because that means there’s going to be more tenants that are looking to rent while they’re trying to buy property as well.

So we’re either looking for high growth locations or we do what we can do here and actually make additional repayments. One of the biggest tricks that we make is we get told by the bank, “Here’s your 25 or 30 year loan turn. Your repayments are $300 a week. We’re on $150,000 a year.” So instead of looking at our $300 a week repayments and going, “Hey, well why don’t we make it $600 a week or $700 a week,” which is putting in 20 to $30,000 extra into our mortgage each year, we go, “Hey, why don’t we buy a new car?” I would’ve said commodore but commodore’s aren’t here anymore let’s buy a BMW or let’s buy a Ford Titan or whatever.

And so we had other luxury costs instead of putting additional money into our mortgage. The benefit of building equity is then we can start bolting on other properties to our portfolio. With the same premise that we’re trying to buy properties in a portfolio where they’re going to go up in value. And so in this example here, we’ve paid down their mortgage, let’s say we’ve done it in five years, be conservative. We’ve knocked got $100,000 off our mortgage and the property is growing by 100,000, it’s in a good market and so we’ve got $200,000 in equity. So we’ve got property number one and all we need is 10 or 20% depending on our strategy to buy property number two. Now what do we do? Do we start funneling money into this investment property or do we funnel money into the owner occupied properties? Always, tip number one, own an occupied property because that property doesn’t have tax deductible debt.

Okay so we want to keep building equity in this property not in this property. We’re happy to take equity through growth, but we don’t really want to take equity through reducing the mortgage because our strategy is to knock this loan off first as fast as possible. Then once we’ve done that, we can start funneling our wage income into this to start helping that dip. So as we start building our equity here or here, we can start looking at bolting multiple houses into our portfolio. So if we’re looking at this example here, if we want a 20% deposit and we’re buying an investment property for 400,000 well that means we need $80,000 in equity. We’re not drawing that money out. What we’re doing is that this is 400, we’re just is limiting the loan balance on this property that’s available to us, right?

So in this example here where it’s worth 500 and not 400, if we’re taking 80% or 20% and let’s say by cost, this aside we’re using 100,000. That means we’ve still got here another 100,000 in equity available to us with this property, which means if we keep paying this down, we can then start looking at another property, investment property number two. How do we manage our money in this example? Multiple offset accounts is fantastic and offset accounts gives us an ability to play with our money more agile than what we can do if we only use a redraw facility. So what I would do is managing our loans. I would have a loan offset account for investment property one, investment property two and investment properties three and then I would also have our everyday living, you probably can’t read, that offset account.

Okay. With the beauty with the offset accounts, we can pull the money out if we need to to just go into another investment property. So it allows more maneuverability. And again, if we start getting growth in these properties here, the beauty of what happens is we can then have more equity, which technically you could hypothetically bolt onto this to allow us to purchase more properties. However, we have to remember there’s two components to getting a loan. One is the deposit, which is either cash or equity in our property and the other is income. And with modern banking it’s a lot more difficult to get loans because they’re more onerous now on our income and our everyday expenditure. So even though we have a lot of equity, it may be difficult, depending on our income situation to get loans from multiple investment properties.

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