Let’s look at what can happen when we release and invest our equity.
Let’s assume that our home is worth, say £250,000 and that we have an outstanding mortgage of only £50,000. So we’re assuming that we have about £200,000 in equity. Really the figures in this example are not that important, just the principle.
We’ll look at this over a nine year time frame because over the last fifty years, average house prices in the UK have risen by 8% per annum, meaning that, on average, they double every nine years. If you think we are unlikely to see growth like that over the next nine years, and you might be right, don’t worry. We’ll also look at what happens when we assume a much more pessimistic outlook.
Our first choice is to do nothing. What happens then? After nine years our home will be worth £500,000. We will still have a mortgage of £50,000, assuming it is interest only, meaning that we now have equity of £450,000. In other words, our equity has increased by £250,000 just by sitting back and letting the property market run its normal course. Except that inflation will have been eating away at our equity and in real terms, in today’s value, even assuming an inflation rate of just 2%, the increase in equity will only be £200,000.
But using the “raw figures”, if we do nothing, we will be £250,000 “better off” in cash terms and £200,000 better off in real terms.
Of course, doing nothing is a bit ‘lame’ so let’s assume we use our equity a little more aggressively. Let’s assume that, as home owners, we can borrow up to 80% of the value of our property.
80% of £250,000 is £200,000. So we can release £200,000 less the £50,000 we already owe, that is £150,000.
We’re now going to gear those funds up and buy some investment property, or even properties. Again, for our purposes, that’s an unimportant detail. We’ll get an 80% buy to let mortgage, at the time of writing the best deal on offer, and there’ll be costs for which we’ll allow £15,000. So by using our net £135,000 as the 20% ‘balance’, we’ll buy a property or properties worth, say, £675,000 with mortgages of £540,000
Let’s look at what happens after nine years.
First, there’s our own home. Our home has doubled in value and is now worth £500,000. We still have the mortgage of £200,000 so the equity is now £300,000.
Next, let’s look at the investment properties.
The value of the investment properties has grown from £675,000 to £1,350,000 but with a mortgage of only £540,000. So the equity in our investment properties is now £810,000, up from £135,000.
So, the total value of our equity is now £300,000 (the equity in our own home) plus £810,000 (the equity in our investments) making £1,110,000.
By releasing the equity and reinvesting we are £860,000 (in cash terms) better off than if we did nothing.
Here’s to successful property investing.
Peter Jones B.Sc FRICS
Chartered Surveyor, Author & Property Investor