The true power of equity

20th July 2007

Australian homebuyers who fail to realise that their first home is potentially a great investment as well as a place to live can miss out on the wealth-creating tool of equity, Australian Property Investor magazine's July issue reveals.

Some Australians' closest encounter with the concept of equity might be the memorable bank TV ad campaign in which a man washing his boat is asked how he could afford such a prized possession. "Equity, mate," is his simple reply.

The truth about equity, API editor Eynas Brodie says, is that it can do much more than help you buy depreciating assets like a boat. Used correctly, equity can provide a stepping stone to help investors buy more appreciating assets.

"Equity is a property investor's most powerful tool in the quest for financial freedom and you can use it to leapfrog into more investments," Brodie says.

"Simply put, equity is the current market value of an asset less the debt that's owed on that asset," she explains.

"As it applies to real estate, equity is essentially the portion of a property that you own outright. So if you have a $300,000 property and you owe the bank $200,000 then you have $100,000 - or 30 per cent - worth of equity.

"Once you have equity in a property, you can leverage off that equity to borrow more money to buy a boat - or better yet, an investment property that will help you move closer to your long-term financial goals."

Equity is generally built up through debt reduction - the repayments you make on your mortgage - and through capital growth, API notes. But what many first homebuyers may not realise is that their first step into the property market can be crucial.

"Your first purchase is critical and its potential for growth in the early years is very important," Stuart Wemyss, director of mortgage broking firm ProSolution Private Clients, tells API.

"Buying a property that languishes in the first five years but starts to do really well thereafter might be okay over the long term but it isn't necessarily going to help you increase you asset base. Whereas if you buy something that grows at 8 to 10 per cent each year on average from year one, that will really help you build a portfolio."

Brodie says starry-eyed house hunters making their initial foray into the property market shouldn't overlook the long-term impact their first home can have on their ability to build wealth.

Brodie says starry-eyed house hunters making their initial foray into the property market shouldn't overlook the long-term impact their first home can have on their ability to build wealth.

"We're not taught to think long term, so many of us make that vital and often most expensive life purchase with little consideration for its ability to build equity through natural compounding growth," she says.

"Obviously today's first homebuyers have a lot on their mind - not least simply overcoming the affordability issues in the current market - but if they can give some thought to the investment potential of the property they're buying then they can start to tap into the benefits of equity from the day they move into their first home.

"If they purchase a good quality asset, they can simply move in and let capital growth work its magic over a few years, then refinance to release the equity in that home, providing a deposit they can use to buy their first investment.

"This is the true power of equity - giving homebuyers the ability to step up the property ladder."

 

© Australian Property Investor magazine - www.apimagazine.com.au. Reproduced with permission. To subscribe to API, go to www.apimagazine.com.au or pick up a copy from your local newsagent.

Read More Articles in our Archives »