In this article we look at an example case study demonstrating how to use the equity from your first home to use as a deposit to purchase your next property. This is the strategy used by most successful property investors for property portfolio growth and long term wealth creation.
Case Study – How to turn your first home into an investment property.. and upgrade without saving for a deposit!
Peter and Lois have outgrown their first family home and are looking to move their 3 kids and dog into a larger property. They were considering selling their first home to buy their new home but decided to turn their first home into an investment property. Peter and Lois initially thought they would not be able to afford the deposit and repayments required to own 2 houses! But after receiving professional advice from Empowered Finance they realised that not only was it achievable – it made sense in the current Perth market. As they are buying in a subdued market and not having to sell their first home in the same market, they will be likely to make capital gains and generate wealth.
Peter and Lois built their first home in Cockburn (Property A), which cost them $500,000 in total – $380,000 for the land and $220,000 to build their home. They had a deposit of $100,000 and borrowed $400,000 from ANZ Bank.
Property A has recently been valued at $600,000 and a potential rental income of $500 per week if rented out to tenants. Over the past 6 years, Peter and Lois have managed to reduce their existing ANZ mortgage to $340,000. Their current interest rate is 4.8%, making their monthly repayments approximately $1,784. (see figure below)
As Peter and Lois are buying in the current Perth “buyer’s market” and are not relying on their existing home to sell to enable them to purchase their new home they have the luxury of a large selection of properties. After watching the property market for some time they pick the perfect property in Coogee (Property B) to move their family of 5, dog and cat into. The asking price is $700,000.
Their plan is to move into the new house in Coogee and rent out their existing property in Cockburn to tenants for $500 per week.
As this will be their 2nd home they will need to pay Stamp Duty this time. Stamp Duty based on a purchase price of $700,000 would be approximately $28,000 (see figure below) making the total funds required to purchase $728,000.
As the property being purchased is valued at $700,000 Peter and Lois can borrow up to 85% without paying Lender’s Mortgage Insurance (LMI). This will result in a new loan amount of $595,000, leaving a shortfall of $133,000.
So I guess you are wondering how on earth did Peter and Lois save $133,000 cash? Well. They didn’t – they used their equity.
As Property A has been valued at $600,000 Peter and Lois can borrow up to 80% of this value. This means that they can borrow $480,000. Keeping in mind that the current loan balance is $340,000 this enables Peter and Lois to borrow an extra $140,000 to use as their deposit to purchase their new property. As their existing mortgage was 6 years old we were able to get a better rate, reducing the rate from 4.8% to 4.2%.
As Property A is now going to be an investment property, Peter and Lois’ accountant Max has advised them to change the repayments to Interest Only to assist cash flow. This means the repayments for the new loan amount of $480,000 are $1,680. (see figure below)
The loan for the purchase of the new property is $595,000 and as this is an Owner Occupied property the repayments will be Principle & Interest. The rate is 4.00%. Based on this the repayments for the new loan are approximately $2,840. (see figure below)
So now you’re thinking – how the bloody hell can Peter and Lois afford those repayments, right?
Let’s do the maths.
The current total existing monthly repayments are approximately $1,783 whereas the proposed total monthly repayments would be $4,520.
So I’m guessing that new repayment figure of $4,520 is a bit daunting! But don’t forget – we haven’t taken into account the rent received from the Cockburn property.
Peter and Lois will receive approximately $2,000 per month. [Calculation = $500pw x 52 weeks / 12 months = $2,166 – rounded down to $2,000 per month to take into account property management costs]
This brings down the new monthly repayments (net) to $2,520. In comparison to the existing repayments of $1,783 this is an increase of $737 per month (or $170 per week).
So what is the bottom line?
The bottom line for Peter and Lois is for an extra $737 per month they get the following:
- Upgrade their family home to a larger property to accommodate their growing family
- They can take advantage of the poor Perth property market by buying a property and not having to sell their existing property.
- Increase their property portfolio to $1.3 million
- Have someone else pay 1 of their mortgages
- Potential tax minimisation savings
If you would like personalised professional finance advice on how to kick start your property portfolio please contact us on 1800 195 123 or [email protected]
Note: This case study is fictional and is provided for general information only and does not constitute personal advice.