Equity built up in 1st home as a 'deposit on a 2nd property?

[Chunk49]

Hi

First time buyer here who is always thinking ahead. About to buy my first property. Around year 5 or 6 I should have decent equity built up in the property (a flat). If I then wanted to, for example, buy a family house (and rent the flat), could I use the e.g. 20% equity built up in the flat in lieu of a 20% deposit for the purposes of obtaining a mortgage on the second property? It strikes me though, that, in relation to a 'real' (i.e. cash) deposit, that cash actually goes to the Seller in the course of purchasing the property and so in fact contributes to the purchase price as well as providing a comfort buffer for the bank. In this case, however, the equity 'deposit' would only serve as LtV / 'comfort' for the lender (and not also contribute to the purchase monies). The bank would in fact be providing a 100% mortgage on the second property, albeit with the 'security' of a 2nd ranking charge over the built equity in my first flat (together with the normal first ranking charge over the property the bank is financing). Is this analysis correct? Newb here so I imagine there will be some school boy errors in the above. Bear with me though, I catch-on quickly ;-)

Thanks for your time.

[zbc]

Doubtless someone with more experience will be along in a minute but I would say that you would be unlikely to find a lender willing to get involved in such a scheme in today's climate.

Our situation was slightly different but we remortgaged our old home and put it on a BTL mortgage and took the cash that this released to use as a deposit on our new home. The two houses were in different countries which added some extra complexity but this way was a lot easier than what you describe.

Good luck

[Chunk49]

zbc said:

Doubtless someone with more experience will be along in a minute but I would say that you would be unlikely to find a lender willing to get involved in such a scheme in today's climate.

Our situation was slightly different but we remortgaged our old home and put it on a BTL mortgage and took the cash that this released to use as a deposit on our new home. The two houses were in different countries which added some extra complexity but this way was a lot easier than what you describe.

Good luck

Thanks. I think that's exactly what I'm trying to describe (except I didn't realise that remortgaging would allow you to extract cash from the property).

[Sarnie]

Chunk49 said:

Hi

First time buyer here who is always thinking ahead. About to buy my first property. Around year 5 or 6 I should have decent equity built up in the property (a flat). If I then wanted to, for example, buy a family house (and rent the flat), could I use the e.g. 20% equity built up in the flat in lieu of a 20% deposit for the purposes of obtaining a mortgage on the second property? It strikes me though, that, in relation to a 'real' (i.e. cash) deposit, that cash actually goes to the Seller in the course of purchasing the property and so in fact contributes to the purchase price as well as providing a comfort buffer for the bank. In this case, however, the equity 'deposit' would only serve as LtV / 'comfort' for the lender (and not also contribute to the purchase monies). The bank would in fact be providing a 100% mortgage on the second property, albeit with the 'security' of a 2nd ranking charge over the built equity in my first flat (together with the normal first ranking charge over the property the bank is financing). Is this analysis correct? Newb here so I imagine there will be some school boy errors in the above. Bear with me though, I catch-on quickly ;-)

Thanks for your time.

The way you've described it, no.

To rent out the flat you would need to move it to a BTL product and that will require it's own LTV to be circa 75%. You could take out cash from this property to contribute towards the new property purchase but you wouldn't be able to borrow more than 75% of the flats value.

[Chunk49]

Sarnie said:

Chunk49 said:

Hi

First time buyer here who is always thinking ahead. About to buy my first property. Around year 5 or 6 I should have decent equity built up in the property (a flat). If I then wanted to, for example, buy a family house (and rent the flat), could I use the e.g. 20% equity built up in the flat in lieu of a 20% deposit for the purposes of obtaining a mortgage on the second property? It strikes me though, that, in relation to a 'real' (i.e. cash) deposit, that cash actually goes to the Seller in the course of purchasing the property and so in fact contributes to the purchase price as well as providing a comfort buffer for the bank. In this case, however, the equity 'deposit' would only serve as LtV / 'comfort' for the lender (and not also contribute to the purchase monies). The bank would in fact be providing a 100% mortgage on the second property, albeit with the 'security' of a 2nd ranking charge over the built equity in my first flat (together with the normal first ranking charge over the property the bank is financing). Is this analysis correct? Newb here so I imagine there will be some school boy errors in the above. Bear with me though, I catch-on quickly ;-)

Thanks for your time.

The way you've described it, no.

To rent out the flat you would need to move it to a BTL product and that will require it's own LTV to be circa 75%. You could take out cash from this property to contribute towards the new property purchase but you wouldn't be able to borrow more than 75% of the flats value.

I'd assumed that when I rent out the flat that the mortgage would have to change to BTL. To make things simple then, assume the LtV will be 25% (I'm buying with a 20% deposit so am assuming that with 5 or 6 yrs repayment and appreciation that LtV will be over 25% percent) and the mortgage reverts to BTL.

I think it's probably my fault for not being clear / lack of knowledge.

What I would be trying to do, is, e.g. remortgage the flat (converting mortgage to BTL) as per the above (and rent it out), and take out cash equivalent to e.g. a 10% deposit on the family home I would then buy (with a normal repayment mortgage). It sounds like this can be done but I didn't think I'd actually be able to take out physical cash on remortgaging - how does this work exactly? Feel free to dumb it down.

Thanks a lot.

[Sarnie]

Chunk49 said:

I'd assumed that when I rent out the flat that the mortgage would have to change to BTL. To make things simple then, assume the LtV will be 25% (I'm buying with a 20% deposit so am assuming that with 5 or 6 yrs repayment and appreciation that LtV will be over 25% percent) and the mortgage reverts to BTL.

I think it's probably my fault for not being clear / lack of knowledge.

What I would be trying to do, is, e.g. remortgage the flat (converting mortgage to BTL) as per the above (and rent it out), and take out cash equivalent to e.g. a 10% deposit on the family home I would then buy (with a normal repayment mortgage). It sounds like this can be done but I didn't think I'd actually be able to take out physical cash on remortgaging - how does this work exactly? Feel free to dumb it down.

Thanks a lot.

Yes you can take out the cash when you remortgage it onto a BTL, but only to a maximum of 75% of the flats value.

For example;

You buy a £100k flat with a 20% £20k deposit.

In six years, lets say your balance is down to £65k, you can move it to a BTL product and raise the borrow to 75% which would be £75k.

This would give you £10k towards your deposit for the new property. Whether that is enough is naturally going to depend on the value of the next property you purchase.

[Chunk49]

Sarnie said:

Chunk49 said:

I'd assumed that when I rent out the flat that the mortgage would have to change to BTL. To make things simple then, assume the LtV will be 25% (I'm buying with a 20% deposit so am assuming that with 5 or 6 yrs repayment and appreciation that LtV will be over 25% percent) and the mortgage reverts to BTL.

I think it's probably my fault for not being clear / lack of knowledge.

What I would be trying to do, is, e.g. remortgage the flat (converting mortgage to BTL) as per the above (and rent it out), and take out cash equivalent to e.g. a 10% deposit on the family home I would then buy (with a normal repayment mortgage). It sounds like this can be done but I didn't think I'd actually be able to take out physical cash on remortgaging - how does this work exactly? Feel free to dumb it down.

Thanks a lot.

Yes you can take out the cash when you remortgage it onto a BTL, but only to a maximum of 75% of the flats value.

For example;

You buy a £100k flat with a 20% £20k deposit.

In six years, lets say your balance is down to £65k, you can move it to a BTL product and raise the borrow to 75% which would be £75k.

This would give you £10k towards your deposit for the new property. Whether that is enough is naturally going to depend on the value of the next property you purchase.

OK I see. This is clearly how people built up mini BTL empires prior the crash.

To give the specific numbers:

Flat about to be purchased at £335,000 at 80% LtV.

Assuming my interest rate continues to be around 3% and I make the normal repayments (with no overpayments), an online calculator is telling me that debt will stand at around £208,000 at the end of yesr 7. The reason I'm focusing on the end of year 7 is that I'm getting a 2yr fix to start with and then plan on fixing for 5 yrs on expirty of the 2 yr fix, and hopefully this will coincide nicely with where I plan on being family / marriage wise etc. Assuming growth of 3% a year (compounded) in the value of the property (ignoring whether this is likely or not), an online calculator tells me this puts the value of the property at about £412,000 at the end of year 7.

Call it £200k equity. From what you're saying, I can then then essentially 'cancel'/'repay'/'roll' the existing debt of £208,000 and replace it with a loan of £309,000: £208,000 of the £309,000 goes into repaying/rolling the original loan, the mortgage changes to BTL (with perhaps a higher rate of interest but that's a separate point), I rent the flat out and the clear £300-£400 a month on the rental AND I have £101,000 CASH in hand to use as I see fit (in this case, to use as a deposit on a family home).

Are my workings correct?

If so, I'm right in what I've always said to friends, which is that buying a property is like doing your first leveraged finance buy out.

Edited by Chunk49 on Wednesday 17th July 10:50

[Sarnie]

Chunk49 said:

OK I see. This is clearly how people built up mini BTL empires prior the crash.

To give the specific numbers:

Flat about to be purchased at £335,000 at 80% LtV.

Assuming my interest rate continues to be around 3% and I make the normal repayments (with no overpayments), an online calculator is telling me that debt will stand at around £208,000 at the end of yesr 7. The reason I'm focusing on the end of year 7 is that I'm getting a 2yr fix to start with and then plan on fixing for 5 yrs on expirty of the 2 yr fix, and hopefully this will coincide nicely with where I plan on being family / marriage wise etc. Assuming growth of 3% a year (compounded) in the value of the property (ignoring whether this is likely or not), an online calculator tells me this puts the value of the property at about £412,000 at the end of year 7.

Call it £200k equity. From what you're saying, I can then then essentially 'cancel'/'repay'/'roll' the existing debt of £208,000 and replace it with a loan of £309,000: £208,000 of the £309,000 goes into repaying/rolling the original loan, the mortgage changes to BTL (with perhaps a higher rate of interest but that's a separate point), I rent the flat out and the clear £300-£400 a month on the rental AND I have £101,000 CASH in hand to use as I see fit (in this case, to use as a deposit on a family home).

Are my workings correct?

If so, I'm right in what I've always said to friends, which is that buying a property is like doing your first leveraged finance buy out.

Edited by Chunk49 on Wednesday 17th July 10:50

Yes, technically your workings are sound.

However, the balance of the BTL needs to satisfy the lenders criteria with regards to the rent you would receive, this is how they work it out;

£309,000 x 5% (notional interest rate used, some use up to 7%) = £15,450 in interest per year.

£15,450 / 12 = £1,287 per month

Rent has to be at least 125% of the monthly interest so;

£1,287 x 125% = £1,609 rent needed each month.

If your flat would rent for £1,609 per month or more then it's a 'goer'. If not then you would need to wind back the borrowing figures so that the rent require would be in line with what you would receive.

Your figures are also based on property appreciation which is naturally open to volatility.

[Chunk49]

Sarnie said:

Chunk49 said:

OK I see. This is clearly how people built up mini BTL empires prior the crash.

To give the specific numbers:

Flat about to be purchased at £335,000 at 80% LtV.

Assuming my interest rate continues to be around 3% and I make the normal repayments (with no overpayments), an online calculator is telling me that debt will stand at around £208,000 at the end of yesr 7. The reason I'm focusing on the end of year 7 is that I'm getting a 2yr fix to start with and then plan on fixing for 5 yrs on expirty of the 2 yr fix, and hopefully this will coincide nicely with where I plan on being family / marriage wise etc. Assuming growth of 3% a year (compounded) in the value of the property (ignoring whether this is likely or not), an online calculator tells me this puts the value of the property at about £412,000 at the end of year 7.

Call it £200k equity. From what you're saying, I can then then essentially 'cancel'/'repay'/'roll' the existing debt of £208,000 and replace it with a loan of £309,000: £208,000 of the £309,000 goes into repaying/rolling the original loan, the mortgage changes to BTL (with perhaps a higher rate of interest but that's a separate point), I rent the flat out and the clear £300-£400 a month on the rental AND I have £101,000 CASH in hand to use as I see fit (in this case, to use as a deposit on a family home).

Are my workings correct?

If so, I'm right in what I've always said to friends, which is that buying a property is like doing your first leveraged finance buy out.

Edited by Chunk49 on Wednesday 17th July 10:50

Yes, technically your workings are sound.

However, the balance of the BTL needs to satisfy the lenders criteria with regards to the rent you would receive, this is how they work it out;

£309,000 x 5% (notional interest rate used, some use up to 7%) = £15,450 in interest per year.

£15,450 / 12 = £1,287 per month

Rent has to be at least 125% of the monthly interest so;

£1,287 x 125% = £1,609 rent needed each month.

If your flat would rent for £1,609 per month or more then it's a 'goer'. If not then you would need to wind back the borrowing figures so that the rent require would be in line with what you would receive.

Your figures are also based on property appreciation which is naturally open to volatility.

Ok thanks. Very useful to know and will be factoring into my future plans now.

Is the 5% figure interest only? Is interest only the norm on BTL?

Yes could rent the flat for £1,500 now, so in 5 - 7 years time then I it will clear that easily fingers crossed as rents in London are going up and up.

Well am hoping it will appreciate on average at least 3% a year otherwise I'm financing a very expensive depreciating asset (leverage value aside)! Am hoping that as it's in London and as we eventually recover, that 3% a year average should be achievable, but obviously it's crystal ball territory.

[Sarnie]

Chunk49 said:

Ok thanks. Very useful to know and will be factoring into my future plans now.

Is the 5% figure interest only? Is interest only the norm on BTL?

Yes could rent the flat for £1,500 now, so in 5 - 7 years time then I it will clear that easily fingers crossed as rents in London are going up and up.

Well am hoping it will appreciate on average at least 3% a year otherwise I'm financing a very expensive depreciating asset (leverage value aside)! Am hoping that as it's in London and as we eventually recover, that 3% a year average should be achievable, but obviously it's crystal ball territory.

The 5% figure is based on interest Only. You can of course have it on repayment, but the lender assesses it on an Interest Only basis.

[Chunk49]

Sarnie said:

Chunk49 said:

Ok thanks. Very useful to know and will be factoring into my future plans now.

Is the 5% figure interest only? Is interest only the norm on BTL?

Yes could rent the flat for £1,500 now, so in 5 - 7 years time then I it will clear that easily fingers crossed as rents in London are going up and up.

Well am hoping it will appreciate on average at least 3% a year otherwise I'm financing a very expensive depreciating asset (leverage value aside)! Am hoping that as it's in London and as we eventually recover, that 3% a year average should be achievable, but obviously it's crystal ball territory.

That's very informative, thanks.

The 5% figure is based on interest Only. You can of course have it on repayment, but the lender assesses it on an Interest Only basis.

[smckeown]

You should also consider what would happen if interest rates went upto 15% again. You'd awfully exposed

[Chunk49]

smckeown said:

You should also consider what would happen if interest rates went upto 15% again. You'd awfully exposed

True. I don't have a crystal ball but hopefully that won't happen. Fixing can obviously attempt to remove that risk too.

[Kudos]

Will interest rates be as low as they are today in 7 years? Highly unlikely

[Chunk49]

Kudos said:

Will interest rates be as low as they are today in 7 years? Highly unlikely

Agreed.

[Condi]

3% interest rates seems a bit low. Is that the 'headline' rate or the BoE rate?

Its pretty easy to see BoE rates going to 3% within 7 years, at which point you would be looking at somewhere around 5-7% on a mortgage.

[Chunk49]

Condi said:

3% interest rates seems a bit low. Is that the 'headline' rate or the BoE rate?

Its pretty easy to see BoE rates going to 3% within 7 years, at which point you would be looking at somewhere around 5-7% on a mortgage.

Yes certainly well possible. I'm hoping to fix for 5 yrs after my initial 2 yr fix to remove that very risk and hoping that the progression of my earnings over the following 5 years together with the additional equity in the flat and (hopefully) converting to an interest only BTL, will see me right.

[walm]

Other than optimism around house price inflation and interest rates your numbers are sound.
However, don't forget some of the quite substantial costs involved in house buying.
Say you have that £100k available for deposit on your 2nd property.

You are going to live there right?
So up until then you have been living in a house worth (on your own figures) £412k.
A reasonable "step up" (since you have been living there for 7 years and getting pay rises and saving diligently you "deserve" a better house right?) is going to have you looking at say c.£500k houses with an extra bedroom or better location or whatever.

So that is a cheeky £25k in stamp duty.
So the deposit you actually end up with is more like £75k at best which is only a 15% deposit on a £500k house.
So you will be punished by the high LTV giving you crappy rates.

You will most likely still want a 20% deposit to secure the very best rates which means you need at least another £25k in savings.

So don't bank on the refi of your first home to have you easily stepping up into a new home.

[Chunk49]

walm said:

Other than optimism around house price inflation and interest rates your numbers are sound.
However, don't forget some of the quite substantial costs involved in house buying.
Say you have that £100k available for deposit on your 2nd property.

You are going to live there right?
So up until then you have been living in a house worth (on your own figures) £412k.
A reasonable "step up" (since you have been living there for 7 years and getting pay rises and saving diligently you "deserve" a better house right?) is going to have you looking at say c.£500k houses with an extra bedroom or better location or whatever.

So that is a cheeky £25k in stamp duty.
So the deposit you actually end up with is more like £75k at best which is only a 15% deposit on a £500k house.
So you will be punished by the high LTV giving you crappy rates.

You will most likely still want a 20% deposit to secure the very best rates which means you need at least another £25k in savings.

So don't bank on the refi of your first home to have you easily stepping up into a new home.

Thanks for taking the time to set out the above, that's very helpful. Agree am going to need probably at least another chunk of my own savings over that period to supplement the refi money.

Re interest rate (i.e. what I would actually be charged) - not expecting that to be anywhere close to 3% in 7yrs time (especially on the house I would buy as LTV will be max 20%). I'm confident that if I can fix for 5 yrs in 2yrs time that I'll be able to achieve a rate around 3 - 3.5% (same as now, but with better LtV, no longer first time buyer and against that factoring a very small potential increase in base rate). I don't think that is overly optomistic but it's obviously crystal ball territory. Anyone any thoughts?

Re 3% growth compounded, I just read that Savilles has increased its prediction of house price growth over the next 5 years to 18.1%, so if that plays out, my figures there wouldn't be far off. Again, crystal ball territory. Thoughts?

[walm]

Chunk49 said:

I'm confident that if I can fix for 5 yrs in 2yrs time that I'll be able to achieve a rate around 3 - 3.5% (same as now, but with better LtV, no longer first time buyer and against that factoring a very small potential increase in base rate). I don't think that is overly optimistic but it's obviously crystal ball territory. Anyone any thoughts?

A few thoughts:
The 5 year spread is always wider than the 2 year spread (since obviously whoever is lending you the money is taking a much bigger risk on how underlying interest rates move over a 5 year period versus a 2 year period). Plus 2-3 years is typically the most common fix so is the most competitive.

Offsetting that will be a higher LTV - although that in itself is a gamble since 5-10% used to be the norm for reasonable rates and owing to the credit cruch it is now way higher. Nobody expected the Spanish Inquisition.... so the LTV requirement for best rates may be higher when you come to refi (unlikely IMHO but not risk free).

Perhaps more important is what base rate is going to do.
To see what the rest of the world is thinking you can check out the forward yield curves which pretty much all have base rates normalising around 4% within 10 years. Call it up 50bps per annum to be conservative.
So in two years, the rate might well be around 1.5% which coupled with a 300bps spread could see you nearer 4.5% for the equivalent TWO year fix (in two years' time). And as above most likely more expensive for a longer fix (LTV dependent).

And remember the better the economy does the steeper the yield curve so base rates at 2-4% sooner than expected is absolutely a risk.

If I were you - I might consider a longer first fix. Sure you might THINK you can get an equivalent rate in 2 years time but why take the risk.
I don't know what the current delta is between 2 and 5 year fixes but it is something to consider for your own peace of mind.