What is equity and how do I improve it and use it?

Firstly, for the purposes of the article and the business we are in, by equity we mean the value created in your house if you were to sell and pay off any outstanding debt.

So, if your house is worth $1,000,000 and you have a $250,000 mortgage, the equity is $750,000.

Some ways to improve your equity position are:

1. Pay down the mortgage – obviously the quicker you pay down the loan, the quicker you create equity. For example, linking back to the example above, if you reduce your mortgage to $200,000 and the house is still worth $1,000,000, you now have $800,000 equity.
2. Create value in your home – by this we mean home improvements such as renovating kitchens and bathrooms. Some things will add more value than others! The ideal situation is when you might spend $100,000 on new kitchens and bathrooms, and your value goes up more than you spend. For example, you have a mortgage of $200,000, you spend/borrow $100,000 on renovations, you then have the house valued at $1,150,000 and mortgage $300,000. Meaning equity is now $850,000 and a $100,000 investment has added $150,000 of value. There are plenty of articles out there on how to add value to your home and it’s worth searching them out. Adding an extra room is another example of what might add value and thus increase equity.
3. Capital gain – as everyone knows, over a long period of time, property tends to increase in value. Though this is not a ‘given’ and changes in Government, supply, economic environment, interest rates etc etc can affect the rate of capital gain. But if you purchased your home for $1,000,000 in 2010, chances are it’s now worth $2,000,000 or more. If you have been paying off the mortgage and not added to it, then you’ve created more equity.

Of course, if you borrow money against the house for things like travel and cars, or house values drop, then your equity can decrease.

Creating equity does provide potential to buy more property through leverage. So, the most common way property investors build a portfolio is through leverage. That means using equity as security to borrow more money to buy another house(s) as rentals.

Not all equity can be used however, as banks want to see you keep at least 20% equity in your owner-occupied house (or maximum lend 80% against the value) and 35% equity in any existing rental (or maximum lend 65% against the value, excl new builds).

For example, if the property you live in is worth $1,000,000 and you have a $250,000 mortgage. You could borrow up to 80% of $1,000,000 to create as a deposit to buy a rental 100% financed.

That means $1,000,000 x 80% = $800,000 maximum borrowing against the family home. Less the existing mortgage of $250,000, means $550,000 available equity to leverage with. If we need a 35% deposit to buy a rental (based on current RBNZ rules), then $550,000 is 35% of a $1,571,000 property(s). So that means $1,571,000 worth of property could be 100% financed.

Another way to look at it is you could top up your existing mortgage by $550,000, so maximum 80% lent just against the family home, and buy a new rental for $550,000. Thus, leaving that new rental with no mortgage, and having it available mortgage free to leverage off in future.

Now the above examples are all hypothetical and it’s a lot more complicated when it comes to borrowing money as income and serviceability are also the other key parts of the process.

But if you are interested to know what your equity is and how to tap into it, feel free to reach out to us!