Using your equity to buy an investment property

If you own a home and want to buy another property to invest in, you might think about tapping into the equity you've built up in your current home. But what does ‘equity’ really mean, and how can you use it?

What is equity?

Equity is the extra value your home has gained since you bought it, minus what you still owe on your mortgage. So, if your home is worth more than what you owe, you may have some equity to play with.

Let's say your home is valued at $600,000, but you only owe $400,000 on your mortgage. That means you have $200,000 in equity.

Equity can build up over time as you pay off more of your loan amount with principal and interest repayments, and if the value of your home goes up.

What is usable equity?

Usable equity is the part of your equity that you can use for other things, like taking out a loan. To figure out how much usable equity you have, you take 80% of your home's value and subtract what you still owe on your mortgage.

For instance, if your home is valued at $500,000 and you owe $150,000, your usable equity would be $250,000.

This is how useable equity is usually calculated:

$500,000 x 0.8 = $400,000 

$400,000 – $150,000 = $250,000 in useable equity  

Your lender or mortgage broker may require a formal bank valuation to determine the current value of your home and to calculate the usable equity you have available.

Using your equity

For homeowners, using this equity to help fund a new investment property is an option. You could unlock funds that can serve as a deposit for a second home. In this scenario, your current property acts as collateral for the additional debt incurred.

There are different ways to do it, like topping up your loan or setting up a separate loan account. Let's break down what you need to know about these options.

Home loan top ups

One common method to use your equity is getting a home loan top-up or increase. This means applying to raise your existing home loan limit, so providing you with the necessary funds for the investment property deposit. The top-up amount is released as cash, which you can then allocate towards securing the investment property.

However, securing a home loan top up hinges on various factors including your:

• financial standing
• income
• employment status
• and existing debts.

It's essential to consult with your lender to determine if this option aligns with your circumstances.

It's important to note that opting for a home loan top-up means an increase in your loan balance and ongoing repayments over the original loan term. As you borrow more money, your repayments will naturally go up. Additionally, this approach maintains the same loan term, but with a higher principal amount accruing interest. Using a repayment calculator can provide insights into the potential impact on your repayments.

Supplementary loan account

If you'd rather not increase your current home loan balance, there may be another option. You could use your equity to set up a new supplementary loan account. This gives you some flexibility—you can pick different features compared to your current home loan. For instance, you could go for a new repayment schedule or choose a different interest rate, like a fixed rate.

When you tap into your equity with a separate loan, you might go for a different loan term. Just keep in mind, this new loan might stretch out longer than your current one, meaning you'll be paying interest for more years overall.

Cross-Collateralisation

Another approach some investors use to leverage their usable equity is called cross-collateralisation.

It generally works like this: you use your existing property as collateral and bundle it with the new loan for your investment property. So, you end up with two loans:

• Your original mortgage, secured by your existing property.
• A new mortgage, secured by both your existing property and the new investment property.

While this strategy could help with the purchase, it's not as flexible as other options. Having both properties tied up in one loan might have drawbacks down the line. For example, if you want to sell one of the properties, your lender might need to rework the loan for the one you're keeping. That means dealing with new paperwork, account numbers, and bank valuations.

What to consider before using your equity for property investment

Before tapping into the equity in your home for property investment, it's important to consider some key factors.

• Make sure that you can handle the additional repayments and associated costs that come with owning an investment property, especially if it ends up being negatively geared.
• Assess your cash flow carefully to ensure you can manage the new repayment obligations. Juggling multiple loans with different repayment amounts, schedules, and terms requires careful organization.
• Having a well-thought-out investment strategy and conducting thorough research are equally important. Long-term investments tend to be more stable compared to short-term ventures, which can be inherently riskier.
• Understand that every method of leveraging equity for investment carries significant risk. Defaulting on any of your loans could result in the loss of one or more assets. Additionally, there are tax implications to consider, underscoring the importance of seeking expert advice before making any decisions.

Before proceeding with accessing your usable equity, take the time to explore all available options, seek professional guidance from your accountant or tax adviser, and carefully evaluate what aligns best with your financial goals and circumstances.