Can you use equity as a deposit?

Equity represents the portion of your home's value that you own outright as you gradually repay your mortgage balance. Building equity signifies significant progress towards complete homeownership.

If you're thinking about purchasing another property, you might be wondering: can you release equity in your existing home to secure a down payment for a new one?

Let's explore the ins and outs of tapping into your home's equity for that next big move.

Can you use equity as a deposit for a new home?

Let's get the big question out of the way. Yes, you can use equity in your current home as a deposit on a new home - but this isn't as simple as it sounds. Accessing your equity, especially through a mortgage scheme, depends on a number of factors, including:

• Your existing mortgage contract
• How much equity you actually have in your home
• The length of time you've owned your home

Before you consider using equity as a deposit...

Using equity as a deposit is a smart move - but not risk-averse.

Leveraging equity in your current property will take you into additional debt, potentially affecting future flexibility and borrowing capacity. What's more, if you're borrowing against your existing property's equity, you'll likely have higher monthly mortgage payments, combining both primary and secondary mortgages.

So before you use equity to finance a deposit for your new home, consider these alternatives to fund your new move...

• Utilise any savings and investments you have.
• Utilise any early inheritance or gifts.
• Sell other assets to cover your deposit.
• Take out a personal or family loan.

The pros and cons of buying a second home

If you're thinking about using the positive equity from your current place to buy a second home, renting it out to cover mortgage costs is a common move among folks with a second property.

Before you jump in, it's good to weigh the perks of owning and renting this house against other investment options...

The pros

1. It can pay for itself

One of the primary advantages of owning an investment property is the potential rental income. By letting out the property, you can generate a consistent stream of income, helping offset outstanding mortgage payments, maintenance costs, and other expenses.

Over time, rental income could provide a significant return on investment.

2. You can actually use it

Apart from investment purposes, owning a second property in the UK provides you with a holiday home, weekend getaway, or future retirement residence. You can enjoy the property for personal use while benefiting from potential rental income when not in use.

3. Future opportunities for your family

Property ownership allows you to build and leave a legacy for future generations. You can pass down properties to heirs, providing financial security, wealth accumulation, and inheritance benefits.

The cons

1. Buying a Buy-to-Let property comes with a lot of expenses

Some of which can fly under the radar: Stamp Duty, mortgage interest, tax on rent, maintenance, the months your property is empty between renters. Every area is different, with varying rental yields and regulations, especially if you're looking to go the Airbnb route.

Alternative investments, such as investing in a portfolio, can be less expensive. You only need to pay the monthly or annual fee for your portfolio.

2. Buying another home is a high-risk venture

This can make your finances vulnerable to fluctuations in the property market. House prices go up and down all the time. If your new property loses market value, you could go into negative equity. This, along with high interest rates, could lead to even more expensive monthly repayments.

A portfolio containing different assets on the other hand, is protected because it is diverse and doesn't rely on the strength of a single market.

Four ways to release equity for a deposit

So, how do you release your equity as a deposit? Here are four ways you can do just that:

1. Sell your property outright

If you're looking for a new home and don't need a second residence, the most simple solution is to sell your current home, access your profits, and use the proceeds as a deposit for a new mortgage. This is suitable for both downsizing and upsizing, with one requiring a smaller deposit than the latter.

2. Remortgage your home and rent out the new property

If you want a second residence for a holiday home or an Airbnb, one common method is to remortgage your current home. By remortgaging, you could release some of the equity in the form of cash, which can then be used as a deposit for the new home purchase.

There may be some difficulties in accomplishing this. A mortgage lender can have specific restrictions or policies that limit your ability to remortgage for the purpose of financing a second residential property. The reasons for such restrictions vary based on the lender policy, risk assessments, and lending criteria.

If you do manage to remortgage your main residence, you'll need to release enough equity to raise a cash deposit of at least 25%. It's also worth researching comparable rental yields in the local area on analysis sites like AirDNA. You need to make sure you're receiving enough in custom to finance the mortgage and repayments.

Find a mortgage provider that offers holiday home, Airbnb, or Buy-to-Let mortgages. Make sure you have enough to pay Stamp Duty (usually higher rate, a 3% minimum on BTL purchases). Pay the outstanding mortgage amount using the rental income you receive.

If you Airbnb the property, you'll have some flexibility to stay at your new property from time to time. It's worth noting however, that some areas have rules on the duration of time a property can be an Airbnb. Cities like London, have a 90-day rule - your property will no longer be able to be advertised via Airbnb after you exceed this duration.

Alternatively, you might consider securing a Let-to-Buy mortgage from a lender. With this arrangement, you move out of your existing home, renting it out to tenants, and reside in your newly purchased home.

3. Take out an equity release scheme

For older homeowners who might not want to move but need cash, there are equity release schemes like a Lifetime mortgage.

With a Lifetime mortgage, the lender places a charge on the property and offers the homeowner either a lump sum or a regular income. This can be used to finance a second home purchase.

Generally, the homeowner isn't required to make mortgage payments during their lifetime. Instead, the repayment for the Lifetime Mortgage is settled from the sale proceeds of the property when the homeowner passes away or transitions to a care facility.

Nevertheless, homeowners have the option to repay the mortgage sooner if they wish to.

4. Second charge mortgage

Another option could be taking out a Second Charge mortgage on your existing property. Also known as a secured loan, a Second Charge mortgage uses your equity as collateral, but it sits behind your first charge mortgage in terms of priority.

Summary: Crunch those numbers!

Properties are huge investments - it pays to get them right. That's why it's so important to prepare before you release equity to fund a deposit. Crunch the numbers, work out exactly whether you'll be able to afford two mortgages at once. While mortgage affordability testing is fairly robust, you shouldn't rest on your laurels, especially if you're relying on rental yield to finance mortgage repayments.

If you're unsure about your options, get in touch with a well-reviewed mortgage adviser or broker. Their advice cannot be undervalued in a process like this!