Should I borrow money against my mortgage to buy an investment property?
Michelle Niziol explains how to leverage equity to buy an investment property. She offers guidance on what to consider as there are both risks and opportunities in this strategy
Leveraging your equity or borrowing money on a mortgage gives a borrower the opportunity to quickly expand their portfolio. It is an ideal option for a real estate investor with a successful investment, eager to expand but lacking in capital.
Although leverage opens up considerable opportunities for the borrower, it is not without risk. Borrowing against borrowed money exposes an investor to significant potential profits, but also to significant losses. So much depends on the market and a shrewd, well-executed strategy.
How to leverage equity
Useable equity is defined as 80% of the property value minus the mortgage value. Borrowers are allowed to borrow up to four times the amount of usable equity to purchase another property, such as an investment property.
For example, an individual may own a property worth £400,000. 80% of the house value is £320,000. If they have a mortgage on the property of £220,000, the amount of usable capital 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 rented out to residential or commercial tenants for additional income.
However, borrowing is complex: banks look at a myriad of other sources, such as age, employment status and income, when performing calculations on individuals. It is not advisable to use all available capital at the same time, in the event of an unforeseen emergency.
When to leverage equity
The optimal conditions for leveraging equity occur when property prices and rental prices rise.
If home values and realizable rents decline, loan payments on a property purchased through leveraged equity may become too much to bear.
However, investors should not despair: the market is constantly changing. An investor who has carefully scrutinized the market in the months leading up to price increases will be in the best position to capitalize and be knowledgeable enough to minimize risk.
Research is essential for this type of investment and potential investors should do their due diligence on the state of the market and the status of investments in the region. They should make sure to collect data to determine the value of properties in the area. Look beyond ownership and into the industry.
Is the proposed investment a satellite area entirely dependent on a single employer? Review the employer’s annual reports. Annual reports showing negative numbers may indicate that the company is open to acquisition or moving to a less expensive area.
It is these movements, 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 essential, as the decision to leverage your equity will impact both short-term and long-term goals.
Speak to a qualified financial adviser to develop your long-term investment strategy, to see when (or if) borrowing on this scale fits into your schedule.
Short-term plans should have an exit strategy prepared, and long-term plans should have options to manage market fluctuations.
If you decide to leverage your capital and invest in real estate, it’s important to make sure your return expectations are reasonable. Your research has given some idea of what to expect, but in the world of investing, markets are constantly changing. An area showing a 9% return over 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 the cash flow. In theory, the rent should cover both your mortgage and the cost of repairs, as properties can rack up significant expenses.
To look forward
Potential investors should gather all the information they have to create the most informed view of the market. Knowledge (and advice from a trusted financial advisor) will go a long way in helping investors make the right investment choice.
Michelle Niziol is CEO of IMS Property Group and Michelle Niziol Bespoke Property Investment