Should I Leverage Equity to Purchase an Investment Property?
Leveraging your equity, or borrowing money against a mortgage, gives a borrower the opportunity to rapidly expand their portfolio. It’s an ideal option for a property investor with a successful investment, eager to expand but lacking capital. Leveraging equity opens the borrower up to considerable opportunity but is not without risk. Borrowing against borrowed money exposes an investor to significant potential profits, but to significant losses, as well. So much is reliant on the market, and an astute and well-executed strategy.
How to Leverage Equity
Usable equity is defined as 80% the value of the property less the value of the mortgage. Borrowers are allowed to borrow up to four times the amount of usable equity to buy another property, such as an investment property.
For example, an individual may own a property worth £400,000. 80% of the value of the home is £320,000. If they have a mortgage on the property of £220,000, the amount of usable equity would be £100,000. Using the rule of four, the buyer would multiply the amount of usable equity by four. In theory, the individual could apply to borrow up to £400,000 to invest in another property (or properties). This investment property could be let out to residential or commercial tenants to achieve an additional income. However, borrowing is complex: banks look at a myriad of other sources, such as age, job status, and income, when making calculations about individuals. Using all available equity at once is inadvisable, in the case of an unforeseen emergency.
When to Leverage Equity
The optimum conditions in which to leverage equity occur when house prices and rental prices are rising. Should house values and achievable rents decline, the loan payments on a property purchased through leveraged equity may become too great to bear. However, investors should not despair: the market is constantly changing. An investor who has carefully scrutinised the market in the months ahead of price rises will be best placed to capitalise and be so well-informed as to minimise risk.
Research is critical for this type of investment and potential investors should conduct due diligence about the state of the market, and the state of investments in the area. They should be sure to gather data to determine the value of properties in the area. Look beyond property, and into industry. Is the proposed investment a satellite area dependant entirely on a single employer? Examine the employer’s year on year reports. Yearly reports showing negative figures may indicate that the company is open to acquisition or movement to a less expensive area. It is these moves, in addition to the market in general, that will have the greatest impact on an investment.
After developing your knowledge of the area, having an investment strategy is critical, because the decision to leverage your equity will impact both short and long-term goals. Speak to a qualified financial adviser to develop your long-term investment strategy, to see when (or if) borrowing at this scale fits into your timeline. Short-term plans should have a prepared exit strategy, and long-term plans should have options to handle market fluctuations.
Should you decide to leverage your equity and invest in property, it is important to make sure your yield expectations are reasonable. Your research has given a picture of what to expect, but in the world of investing, markets change constantly. An area reporting a 9% yield for the past five years may not continue to grow. Be sure to choose a mortgage payment that will be payable without a tenant for several months, and always keep an eye on cash flow. In theory, the rent should cover both your mortgage and the cost of any repairs, as properties can amass significant expenses.
Looking to the Future
Potential investors should gather all information available to them, to create the most informed view of the market. Knowledge (and the guidance of a trusted financial adviser) will greatly aid investors in making the correct investment choice.
This article was featured on WhatMortgage.co.uk