How to use equity to buy an investment property
You may be able to borrow money to put towards an investment property purchase by leveraging the equity you have built up in your current property.
Here’s an overview of the key steps:
Find out the value of your property
Real estate websites can give you an estimate of your home's value as a starting point, but bear in mind it's the lender's valuation that actually matters and they tend to value properties at the conservative end of the range.
Calculate your home equity
Use a home equity calculator to work out how much equity you have in your current home based on your property’s value and your current loan amount.
Compare a range of lenders and deals
Compare products from different lenders to find the best deals for you, or work with a mortgage broker who can evaluate multiple options at once. A broker may also help guide you through the process and identify deals you might not have found on your own.
Get professional help if you need it
Mortgage brokers can assist you in making informed decisions about your property goals. These experts can explain your borrowing options in simple terms and ensure your application is strong when you're ready to proceed. They can also give you tips on how to improve your chances of approval.
How much of my home equity can I use?
It’s important to note that you won’t be able to use the full amount of equity in your existing home. This is because most lenders require you to have a loan-to-value ratio (LVR) of 80% or less. For example, if your home is valued at $800,000 and you have a loan balance of $500,000, your usable equity will be $140,000.
You can calculate your usable equity as 80% of the value of your home minus the amount you owe to the bank. In this example:
- Property value: $800,000
- Home loan balance: $500,000
- Total home equity: $300,000
- Usable equity calculation: 80% of $800,000 = $640,000 minus $500,000 (loan balance) = $140,000
Lenders won’t let you use the full amount of equity in your home because they’re protecting themselves from potential losses. Since the loan is secured against the value of your property, they limit how much they lend to ensure that, if house prices drop, the loan doesn’t exceed the property’s value.
How does equity work?
Equity refers to the difference between your property’s current market value and the amount you still owe on your home loan. Essentially, it’s the portion of your home that you “own” outright.
For example, if your home is worth $500,000 and you owe $200,000 on your mortgage, you have $300,000 in equity. You may be able to use this equity to borrow more money, which allows you to buy a second home or investment property without needing a cash deposit. This is typically done by refinancing your existing loan to access the equity.
However, it’s important to note that your borrowing potential isn’t just determined by the amount of equity you have. Lenders will also consider other factors, like your income, expenses and overall financial situation, to assess your ability to repay the loan.
How much of your equity can you afford to spend?
When it comes to buying an investment property, it can be hard to know where to start. But a simple rule of thumb is to multiply your usable equity by four to arrive at your maximum loan amount.
The reason being, lenders typically lend up to 80% of the value of a property, with your equity contribution making up the other 20%.
For example, if you have $100,000 in usable equity in your existing property, it means your maximum purchase price for an investment property could be $400,000. This method provides a rough idea of how much you could borrow, assuming you tick all the lender’s criteria boxes, but ultimately each lender will use its own method to calculate your actual borrowing capacity.
To gain a clearer picture of how much you can afford to spend, it’s best to chat with a mortgage broker or financial advisor. They can assess your overall financial situation and offer guidance on what your best options are.
What to consider before using equity to invest
Here are some tips to consider before dipping your feet into the equity pool:
1
Try not to drain all of your usable equity in one go
Think about leaving some of your usable equity as a buffer to avoid being too exposed if property prices decrease. This way, you'll preserve the equity you've built and reduce the risk of having little left if the market drops.
2
Don’t lose focus on paying your home loan as fast as possible
While using equity to invest in additional properties can be a powerful investment strategy, it's crucial not to lose focus on paying down your mortgage. This may involve depositing more cash into your offset account or making higher repayments (if you have the ability to do so).
3
Expanding your property portfolio will impact your budget
Buying an investment property may require cutting discretionary spending and adjusting your finances. Seeking proper financial advice can help you make informed choices and avoid unnecessary strain.
4
Having usable equity does not mean you are guaranteed to be approved for an investment loan
Lenders will assess other factors like your income and expenses, meaning you’ll still need to meet certain criteria regardless of how much equity you have in your home.
5
What are the tax implications?
Buying an investment property can make you eligible for tax deductions and the benefits of negative gearing. However, the extent of these benefits will depend on your income, financial position and the specifics of your investment property, including expenses like loan interest, council rates and insurance premiums.
Weighing up your investment options
Once you have worked out your usable equity, it’s time to consider your loan options.
This is a good opportunity to perform a financial health check on your home loan and other loans you may have against your property portfolio.
Items you have to check up on include:
- The current interest rate you are paying compared to other lenders and the current fixed rates vs variable rates
- Fees and structures compared against other lenders
- Whether other lenders could offer you a better service based on your current portfolio and loan structure
If you decide to go ahead and access some of your equity, you will need to see if it will result in any extra fees and charges - for example, any breakaway costs if you decide to switch to another lender.
Once you have decided on the best option, now’s the time to contact a lender and get the process started. Or, if you don’t want to go it alone, consider reaching out to a mortgage broker for help.
Using a mortgage broker has many benefits for you as a property investor. Brokers have access to multiple lenders and loan products, saving you plenty of time and stress by doing the research and handling the application for your next property investment loan.
What's the difference between using equity to buy a second home and an investment property?
A second home is a property you plan to live in for at least part of the year or visit regularly, while an investment property is primarily purchased to generate rental income, with tenants typically occupying it year-round. The good news is, you may be able to use the equity in your current home to finance both options.
