Using Home Equity Wisely to Finance Your Granny Flat

If you have a mortgage, you’re probably one of many people wondering if they will ever be able to afford an investment property. Perhaps you’d like a source of passive income by renting to tenants. Or maybe you’d like to provide secure housing for your relatives. With the cost of land to consider, building a new home while paying off your current one doesn’t seem possible, right?

Well, there is a way to build a home without the expense of land and get a leg up on the investment property ladder. For many Aussies, building a Granny Flat in their backyard is the investment strategy they’ve been searching for.

This article explains how to boost your borrowing capacity using the equity in your home. This can help you fund a Granny Flat construction project and get you on the way to building your investment portfolio.

What is Home Equity?

Home equity is the difference between what your home is valued at and the balance of your mortgage. It builds up as you reduce the loan amount with principal and interest repayments. You can use the equity in your home to increase or refinance your mortgage.

Therefore, if you have been paying off your home for a few years and its market value has increased, your equity could be a sizable sum by now. Using your primary residence as collateral, you can use that figure to borrow more money with an equity loan.

If you don’t think you have the budget to build a Granny Flat, it can be worth checking the equity in your home with your lender or by using an online home equity calculator. If you don’t have enough equity in your home to fund Granny Flat construction, the alternative is a construction loan. You can read more about how they work in our article ‘Build or Buy Your Next Home’.

Benefits of Investing in a Granny Flat

Building a Granny Flat can boost your property value by 20-30%. It can also increase the potential rental yield of investment properties by up to 30%. You only have to do a quick Google search to see that, in the current rental market, Granny Flats can rent for as much as a standard home.

Whether you are adding to a property investment with a Granny Flat or are a homeowner looking for passive rental income, Granny Flats have lower upfront construction costs than standalone investment properties.

Granny Flats can be a lower-risk investment in comparison to a home improvement such as a renovation or extension. The latter is subject to budget and timeline blowouts that are not only an inconvenience but also very costly. There’s also a high chance you can’t live in or rent out the home during this construction.

You can read more about the Benefits and Drawbacks of Investing in a Granny Flat in this article.

What Does a Lender Need to See for Equity Home Loans?

When you begin looking at equity home loans, it’s important to shop around. Your current lender may not be offering you the best deal in terms of interest rates or repayment options. Using a mortgage broker for extra information and advice can be helpful in this situation.

You can expect lenders to look at:

• How much equity is in your current property
• How long you have been a homeowner
• Your income and employment status
• Your credit history and credit score
• Any other debts or large expenses you may have

Financing Options Using Home Equity

When using the equity in your home to fund a Granny Flat construction project, you can use either a ‘line of credit’ or ‘cash out’.

A line of credit is a separate mortgage, so it can make it easier to track expenses. However, it involves a lot more paperwork as you’ll be applying for a new Granny Flat loan with your lender.

The cash-out option involves refinancing your home loan and receiving a lump sum. As you are refinancing, you can expect a new interest rate and terms with your lender.

FAQ’s

Can I use home equity if I have an existing mortgage?

Lenders frequently allow homeowners to tap into their home equity for collateral on a new loan. Whether you choose to refinance your mortgage or take out a line of credit, using the equity in your home is a great way to boost your borrowing capacity.

Should I get a cash-out refinance or line of credit?

Both types of equity loans have their pros and cons. The biggest difference is one payment versus two. Speak to a financial advisor to determine which type of loan is best for your circumstances.

What are the tax implications of building a Granny Flat?

The main tax implication of building a Granny Flat is if you decide to sell your home, you may have to pay capital gains tax. Capital Gains Tax is payable on the increased value between when you buy and sell a property.

Is a Granny Flat a good investment in any location?

Demand differs across suburbs and areas. If you’re not sure if a Granny Flat is a good investment where you are, speak with local real estate agents for more specific advice. Also, consider the capital growth on your property, council restrictions, possible rental returns, maintenance costs and any tax deductions you may be eligible for.

Who pays for the cost of water and electricity in a Granny Flat?

Who pays for water and electricity will depend on whether the dwellings are individually metered. If they are not, the property owner and tenant will need to agree on how the costs are to be divided.

Are there any risks involved in using equity for a Granny Flat?

Like with most investments, there are some considerations you should think about before building a Granny Flat. Be aware of over capitalising. If the Granny Flat cost outweighs the value of the property, this could be problematic. Using an experienced builder who knows how to avoid this is a good solution.

Another risk is a budget blowout. Without the right planning, the project could end up costing more than anticipated. Again, seeking an experienced team can ensure you don’t miss any hidden costs.

Granny Flat loans that use the equity built up in a home can be a fantastic way to boost rental income or start making some. However, a Granny Flat is a big investment. We’d always recommend consulting with a financial advisor before jumping into any investment opportunity and carefully considering the pros and cons.

If you think a Granny Flat is a good investment for your future, touch base with the only multi-award-winning Granny Flat builder for design and construction, Granny Flat Solutions. You can start by checking your site for its suitability for a Granny Flat on our website or call us on 1300 259 677 to access our no-obligation site assessment service.