Often, property investors refer to “equity” as the difference between a property’s current value and the mortgage balance(s) secured by it – that is, what they owe.
This definition is meaningful in that it is a good measure of wealth, but arguably, if you never intend to sell the property it’s purely an academic description. Perhaps a more meaningful measure is “borrowable equity”. I define borrowable equity as the amount of money a bank will lend to you using property as security.
Why borrowable equity is more important
Leveraging against assets to invest is a time-tested investment strategy that can work fantastically well (as long as you invest in quality assets, of course).
Maximising your ability to borrow can assist you with many things, including upgrading your home, buying another investment property, investing in the share market and funding short-term cash flow challenges (supplementing living expenses for a few months when you expect cash flow to be tight). Therefore, maximising your borrowable equity is key to ensuring you maximise your financial opportunities. The sooner you can invest in another property, the sooner you will build wealth.
The main factors that determine your borrowable equity include:
• The bank’s assessment of a property’s value
• The bank’s credit criteria (such as the percentage of the property’s value they will lend you)
• The bank’s borrowing capacity (how much you can afford to borrow)
HOW TO INCREASE YOUR BORROWABLE EQUITY
1. Strategies to maximise bank valuations
Property valuations can differ between lenders by large amounts. Valuations on some of the properties I own have differed between banks by 10 per cent to 20 per cent. Switching to a lender with a higher valuation has allowed me to invest in another property. If I hadn’t refinanced, my investment journey would have stalled.
There are a few valuation strategies you can employ:
• Make sure your loans aren’t cross-securitised (interlinked). The reason for this is you need to have the ability to select which properties you would like to revalue at which times. If your loans are cross-securitised, the bank will revalue all properties at the one time and you may not want that to happen in case a lower valuation on one property offsets higher valuations
• Realise that revaluing all properties at the same time might not be best. Of course, different types of property and locations improve at differing rates and times
• Follow the market so you can keep track of comparable sales. Valuers will look for three or more good comparable sales in the past six months to influence their opinion. A property is comparable if the location, land size and accommodation are similar. For example, assume you own a single-fronted Victorian cottage that was valued by the bank 1.5 years ago at $700,000. You have followed the sales in the area and know that two similar Victorian cottages have sold in the same street – one for $800,000 and one for $830,000. Another, two streets away, sold for $850,000 recently. It’s likely that you can expect a valuation to come back at more than $800,000 if you get a new valuation. Therefore, once you have a few comparable sales, request a bank valuation
• Speak to your mortgage broker and see if they think it’s worth ordering more than one valuation. Some banks allow mortgage brokers to order valuations on properties. If another bank revalues your property for materially more than your current lender, it may be worth switching to continue your investment journey
• Make sure your property is clean and well-presented when the valuer inspects it
• If you disagree with the bank’s valuation, request a copy of the report to check the details of your property are correct
• Realise that valuations can be unpredictable at times. Sometimes you can be unlucky and get a conservative valuation. It is difficult to successfully challenge the valuer’s opinion and get the figure revised. Therefore, typically, your only two options are to switch lenders or live with the low valuation
2. Be careful with the type of property you buy
The great thing about unique properties is that they have more scarcity value. Scarcity value should translate into good capital growth.
For example, I know of a property in Prahran, Melbourne, that consists of two two-bedroom, single-fronted Victorian cottages joined together to make one four-bedroom home. It is in a blue-chip location and I suspect that if it was ever put onto the market it would fetch a healthy price. However, when bank valuers assess the property, it is difficult for them to find comparable properties.
In this situation, valuers are more likely to be conservative – and conservative valuations don’t help active investors. Buying a unique property theoretically helps the investor as they have a scarce asset that will likely enjoy strong capital growth. However, this is only relevant if they ever sell the property and realise the value. If they consistently experience conservative bank valuations because of the property’s uniqueness, the property might not help the investor grow their portfolio. This is a good illustration of the difference between theoretical and borrowable equity.
3. Use different lenders in a strategic order
Different lenders use different models for assessing how much a person can afford to borrow. Often it is possible to maximise your borrowing capacity by using certain lenders in a certain order.
Sitting down with your mortgage broker and planning ahead could be a very valuable thing to do. It will allow the broker to consider using certain lenders first, leaving the more generous lenders for future use.
Achieving financial independence is a journey, not a race. You must always borrow well within your capacity, taking into consideration the impact of changes to income, interest rates, allowing for buffers and so forth. Borrowing too much, too soon could result in large financial losses and it’s not worth the risk (and stress).
4. Borrow when you don’t need it
The best time to approach a lender for more borrowings is when you don’t really need it.
Revalue your properties strategically. When you get a higher valuation, increase your lending limits to 80 per cent (or more) of the new valuation. You don’t have to draw the funds so you don’t have to pay interest, but the money is ‘locked in’ and available for a rainy day (or your next investment).
If there is one thing that never changes in people’s lives it’s change itself. People move homes, relocate for work, become self-employed, get retrenched, start a family, and so on.
Making sure you maximise your flexibility – like locking in access to more equity – is key to accommodating the inevitable changes that life brings us. So whilst you might think you have no need for higher credit limits now, if they are available, lock them in.