How does using equity to buy an investment property work?

If you’ve owned your home for a while, you may have built up equity that could help you purchase an investment property.

That doesn’t mean you need to sell your home or have the deposit sitting in cash. Depending on your financial position, you may be able to

access some of the equity in your current property to help fund the deposit and purchasing costs. Using equity to buy an investment property may reduce the amount of cash you need for the deposit and purchasing costs.

What is equity?

Equity is the difference between the current value of your property and the amount you still owe on your home loan.

For example, if your home is worth $1 million and your home loan balance is $500,000, you have approximately $500,000 in equity.

However, that doesn’t necessarily mean you can borrow the entire $500,000.

How much equity can you use?

Many lenders will allow borrowing up to 80% of a property’s value without requiring Lenders Mortgage Insurance.

Using the example above:

• Property value: $1 million

• 80% of the property value: $800,000

• Current home loan: $500,000

• Potential usable equity: approximately $300,000

This is a general example. The amount you can actually access will depend on the lender’s valuation, your income, living expenses, existing debts and overall borrowing capacity.

Having equity doesn’t automatically mean you’ll qualify for the additional loan.

Using equity to buy an investment property

The equity released from your home may be used towards:

• the investment property deposit

• stamp duty

• conveyancing and legal fees

• building and pest inspections

• other eligible purchasing costs

The remaining purchase price would generally be funded by a separate investment loan secured against the new property.

Why should the loans be kept separate?

Loan structure is important.

If you release equity from your home to purchase an investment property, it will usually make sense to place that borrowing in a separate loan split rather than combining it with your existing home loan.

Keeping the borrowing separate makes it easier to identify which funds were used for the investment. It can also make record-keeping and future refinancing much simpler.

The tax treatment of loan interest generally depends on how the borrowed money is used, not which property secures the loan. You should obtain advice from your accountant before proceeding.

What if you want to use the property yourself?

If you’re considering a holiday unit that you’ll use personally for part of the year and rent out at other times, the situation may be different.

The lender will assess whether any proposed rental income can be included when calculating your borrowing capacity. Your accountant can explain how personal use may affect the deductibility of interest and other property expenses.

Should you refinance at the same time?

Sometimes it makes sense to refinance your current home loan while releasing the equity. This may provide access to a more suitable loan structure, a better interest rate or the features you need.

However, the lowest advertised rate isn’t always the best choice. The proposed investment lending, valuation, fees, loan features and total structure should all be considered together.

Refinancing the home loan first and then applying elsewhere for the investment loan shortly afterwards can also create extra work and costs. It’s worth planning the complete structure before submitting applications.

Before using your equity

Before deciding to use equity to invest, consider:

• the repayments on the additional lending

• possible periods without rental income

• property management and maintenance costs

• rates, insurance and body corporate fees

• changes to interest rates

• whether you still have an adequate financial buffer

Using equity can help you purchase sooner, but it also increases the debt secured against your existing home.

A mortgage broker can model the proposed purchase, compare suitable lenders and help structure the loans clearly before you start making offers.

If you’re considering an investment property and want to understand how much equity may be available, get in touch and I can help you work through the numbers.