Using equity in your family home


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Many people get onto the wealth-building path by using the equity they have built in the family home to invest - but taking the first steps can be daunting.

"I have thrown every extra cent into my home loan over the past 10 years and have paid off a fair chunk of it," says Money reader Sean.

"But now I am in my 40s I want to start building a nest egg for my retirement outside super, starting with an investment property. How do I go about accessing the equity I have built in my home to start investing without putting the home at risk?"

Well Sean, using family home equity to start building wealth is a strategy many Australians have employed to their benefit, but that does not guarantee success for everyone who follows it.

The best way to embark on this journey is to carefully research all your options before you move. Being conservative in how much equity you access will lessen any risk to the family home. But bear in mind, all investments do carry some degree of risk.

Sean bought his Melbourne suburban home for $350,000 with a loan of $300,000. It's now worth $550,000 and his loan has shrunk to $100,000, giving him $450,000 equity in the property. And given he has such a good track record of paying his original loan, it's very likely that lenders will be falling over themselves to grab his custom.

The money is there so it's just a matter of how Sean should access it, how much he should access and how he should structure his borrowings.

Many people in Sean's situation think it's best to stick with the same lender for all borrowings.

But if you do this, in most instances your lender will want to merge your home and investment property loan - called cross-collaterisation - and this is rarely good for the borrower.

If things go bad and you default on your investment loan your lender has the right to decide which property it will sell to recover its money - and it could well be the family home. It also makes it more difficult to change lenders, though not impossible, if you find a better deal.

An alternative is to redraw the amount needed for a deposit and costs on an investment property from the home loan. Let's say he finds an investment unit for $300,000 plus costs (including stamp duty) of $20,000.

He could redraw $64,000, and he would have a 20% deposit (avoiding mortgage insurance), still leaving him with $386,000 equity in his home.

His loan will increase to $164,000 and he should make sure this is split into the $100,000 owing on his home and $64,000 for investment.

Sean can go to another lender to borrow the remaining $256,000 (80%) he needs for his unit.

He has used the equity in his home to fund the deposit and costs but each property stands alone as security for each loan. If things go wrong he has choices about what he sells to solve his problems.

Once Sean has built up equity in his investment property he can repeat the process, maybe next time to buy shares, without further risk to the family home.

Any spare cash should be diverted into the part of the mortgage loan paying off the family home as the interest on this is non-deductible.

Having redraw means this loan account can also be used as a source of funds to pay for such things as school fees and any emergencies that may arise.

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Money's founding editor Pam Walkley stepped down in early 2015 after more than 15 years at the helm. Before that she was at the Australian Financial Review for 11 years, holding several key roles including news editor, chief of staff and property editor. Pam is now a senior writer for Money.