In this article I will discuss:
- The definition of equity
- Why equity is so important
- How you can increase equity, passively and actively
- Additional tips to increase equity
At Active Invest a very important aspect to wealth creation is reducing debt and building equity. Equity is sadly a misunderstood and quite an understated financial tool available to home owners. The banks generally do not promote equity mainly because equity is diametrically opposed to the maximum interest a bank can generate from you loan. Equity if deployed correctly can make a drastic affect to your long-term wealth outcomes. Many wealthy people have learnt what equity is and how it can be utilised to build a financial freedom. Who wouldn’t like to achieve this!
What Actually Is Equity?
What is “equity”? Equity is simply the difference between what you owe on your house and the value of your house. As an example, if your house is worth $500,000 and your loan is $100,000 then your equity is $400,000.
Is all my equity available to me? If you were to sell this house, then the equity less selling costs are all yours to use. If you are retaining your house and wish to access the equity, general lending policies maximise this equity to 80%. Ie using the scenario above the equity is $100,000 x 80% = $80,000 is available equity for you to deploy whilst retaining a mortgage on the property. Some lenders and policies allow you to access more, however other lending conditions apply.
Why Is Equity So Important?
Many consumers and investors use a combination of debt and equity financing throughout their life, but there are some distinct advantages of using equity including financing projects opposed to debt financing. Principal among them are the fact that equity financing can provide situations where no repayment obligation and that it provides extra working capital that can be used to grow a person’s wealth if deployed correctly.
People usually have a choice as to whether to seek debt financing or equity financing. The choice most often depends upon which source of funding is most easily accessible for you, the project in planning, its cash flow and how important maintaining control of the project is to its principal owners.
The main advantage of equity is that there is no obligation to repay the equity money acquired through equity financing via regular structured monthly repayments as is the case with a normal term loan. Equity financing places no additional financial immediate cashflow burden on the borrower. Since there are no required monthly payments associated with equity financing, you have more equity cash available to invest in growing your wealth. The more equity you have, the more you can invest to build wealth.
How Does Equity Increase?
Equity is created in two ways.
Equity Increase Method 1: Property prices increase.
Property price increases can occur in 2 sub categories:
This is where we rely solely on the property to increase in value over time. In this situation you are reliant on the market continuing to do the heavy lifting and increase year on year without fail. Problem with relying on this strategy alone is that the property market will cycle through periods of lesser capital growth therefore we cannot rely of high single figure or even double-digit growth. The market will simply not deliver growth for ever. A normal property market will deliver periods of high growth, low growth, no growth and negative growth, this is normal.
Relying on the market to improve to get gains, that’s an old strategy from five to 10 years ago – it doesn’t work like that anymore. You need to use a more creative approach to make sure you’re creating instant equity and starting off on the right foot from the very beginning.” That’s where the active approach comes into play.
This is where we consciously purchase a property a property that can be improved in value (Property Price Rise). We are not considering or waiting for the price to passively rise, we are going to make the value increase in our control, NOT the market controlling us. When you can find a property that presents problems and you have the solution, you WILL make money. The active approach can take shape in numerous outcomes and forms, some being:
- Land Subdivisions
- Development Infill
- Development Knockdown rebuild multiple
Relying on the market to improve to get gains, that’s an old strategy from five to 10 years ago – it doesn’t work like that anymore. You need to use a more creative approach to make sure you’re creating instant equity and starting off on the right foot from the very beginning.”
Recent case studies we have published detail recently completed sites and active sites currently displaying all or some of the strategies listed above. Some sites readily visible via the Internet to show before and after results, they include:
- 38 Cannes Avenue Bonbeach- Knockdown 3 Lot Subdivision
- 29 Kalimna Street Carrum- Infill and renovation 2 Lot Subdivision
- 66 Centenary Street Seaford- Knock down 3 Lot Subdivision
Numerous other live sites are at differing stages of the process including acquisition, council planning, demolition in building tendering etc. The active approach does not necessarily require us to improve immediately, you can combine the passive approach but making sure the property you buy will deliver an Active outcome to accelerate the equity growth.
When buying a site, we recommend you buy a property that can deliver the active outcome when it suits you financially.
Equity Increase Method 2: Debts balances are reduced.
Your balance owing to a bank is crucial, you should be aware of this and do everything possible to reduce debt as fast as possible so you can access available equity to invest Equity, building it and then deploying equity to build wealth is a psychological state of mind issue and clients need to become comfortable with the notion of deploying equity to build wealth. If you do, then you will have overcome one of the biggest hurdles we see today. If you do not, then your wealth creation outcomes may be stifled.
The old school notion was to get a house, commence a loan, have it for 30 years, pay off the one house and then consider your future years with retirement fast approaching. The notion today is vastly different, and you must become familiar with this notion as quickly as you can, understand it, its power, how to build and utilise this in-house powerful tool. Equity if deployed correctly works for YOU, interest if maintained for long periods works for the BANK. We know which financial tool we prefer to work with, this is equity.
Strategies To Build Equity
Strategies to build equity include:
- Offset accounts, with balance kept as low as possible with actual cash in the mortgage. (investors may vary slightly).
- Accelerated fortnightly repayment.
- Refinance your mortgage to a shorter term, ie 15, 20 or 25 years based on your cashflow tolerances’. This will save you thousands in interest.
- Refinance your loan to a lower rate. Example at time of writing most owner-occupied headline rates can be approximately 3.64%-3.69% with investors headline rates around 3.89% -3.99% depending on payment structures. Conditions apply to the rates mentioned.
- 50/50 Rule, this is where you make a pact with yourself, that any additional income you generate, at least 50% goes directly to the mortgage. Every little bit helps like the tax return etc.
- Direct salary credit is where your paymaster pays a portion OR all your salary directly to the mortgage. This is a great strategy for couples who learn to live off one wage and direct the second to debt reduction. The savings can be enormous.
- Create an Income accelerator for yourself. This is a second job, part-time cashflow you obtain and direct this to debt reduction.
- Cash generate from sale of asset or items no longer used. Do not just throw the items, “one mans trash is another person treasure” they are willing to pay some money for. Use that money to reduce your debts.
- Consolidate high interest debts into lower interest packages and concentrate to pay them off quickly, hopefully improving cashflow.
- Recalculate your repayments based on a higher interest rate ie money today at 3.64% but pay at a rate of 5%. This will save you thousands in interest. This also conditions you psychologically for when interest rates do move higher.
- Split your loan into 2 facilities part being fixed and part being variable. Concentrate of the variable facility by implementing any of the ideas above knowing the fixed portion cannot be impacted by rising rates. Make sure you determine the split loan values to provide you some flexibility in the variable portion. Ie if you can pay an extra $30k per annum over 3 years make sure the variable portion limit is set to a minimum of $90k.
- If cashflow and equity allows, commit to an investment property purchase to accelerate equity growth giving you opportunities to pay down debt faster.
- Renovations and subdivisions are a great way to build equity quicker, if completed correctly. The use of equity to fund the renovations, some building activities if possible, improve the properties increasing the price.
During client finance strategy sessions, we discuss these aspects in detail, because our job is to help you build and use equity in a smart, sustainably affordable manner as quickly as possible, so you can redeploy equity to build wealth over time.
Our main goal at Active Invest is help you build wealth. The fist step is to understand how you can use your equity to achieve this very important milestone.