Equity puzzle

Question from Susan updated on 29th August 2011:

I currently own a home that is tenanted. The value of the home is $390,000 and I have a $37,000 mortgage on the property. I am looking at buying another home of around $250,000 and wonder if I am able to use my equity as collateral? I'm not sure how this works.

Our expert Kris Pedersen responded:

As long as your income position meets the lenders requirements and your credit history is relatively clean you should have no problems at all. Be aware that with so much equity in your existing property that if you just go back to the bank which has the current mortgage they are likely to state that they will be able to 100% fund you into the new property by using the existing equity.

I recommend in your case avoiding this situation if possible as by doing so you are effectively putting all of the equity at risk. My recommended way would be just to look at borrowing 20% from your existing lender or $50,000 based on your stated $250,000 purchase price. Then I would recommend approaching a different lender for the remaining funds to complete the purchase or to issue a preapproval based on these numbers.

The reason for only going to 80% funding with the new lender is that generally when you go above the 80% mark you would get charged additional costs such as lenders mortgage insurance premiums. By keeping the loan to value ratios as stated above you are still keeping the majority of equity with one lender and the majority of debt with the other which is far better from an asset protection point of view.

Kris Pedersen of Kris Pedersen Mortgages is a commentator on property and finance. His team sources top finance strategies. www.propertyfs.co.nz

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