Using Equity to Buy Investment Property

How to unlock the equity at your fingertips to add to your property portfolio

Last updated on April 20th, 2022 at 10:55 am by Thomas Perrotta

Using Equity to Buy Investment Property

Are you looking to increase your property portfolio but don’t have the funds in your account? Utilising home equity can be a great solution for this, providing money that you wouldn’t otherwise have access to for real practical purposes. Read more about how you can use equity to buy your next investment property here.

How can I use my equity to buy investment property?

Simply put, the answer to this is to cover your deposit. It can be difficult to afford a lump sum at the start of your home loan, particularly if you’re already paying off an existing home loan. That’s where your home equity comes into play. Electing to make use of your usable equity as a deposit can give you a clear idea of what kind of budget you’ll be looking at for your investment property. Property investors find this to be an incredibly useful and effective means of funding property deposits when their money is tied up elsewhere, with rental income then assisting them in the repayment of their home loan/s.

How does equity work for buying investment property?

Equity is calculated using the following simple equation:

property value – amount owed = equity

An example of this might be:

  • Property value: $550,000
  • Amount owed: $300,000
  • $550,000 – $300,000 = $250,000 (equity)
 

When it comes to the amount you’re able to access, lenders will generally only allow you to borrow equity equal to 80% of your property’s value or less. Therefore, the equation to work out usable equity is:

(property value x maximum equity %) – amount owed = usable equity

  • $440,000 – $300,000 = $140,000 (usable equity)
 

The 20% deposit being multiplied by four rather than five is done for a specific purpose. This is referred to as “the rule of four” and it covers the approximately cost of extra charges like stamp duty and other upfront fees which ultimately amount to around 5% of the property’s value.

The pros and cons of using equity to buy investment property

PROS

Dodging LMI

Lender’s Mortgage Insurance (LMI) is a costly charge that borrowers will usually have to pay with LVRs above 80%, but utilising the equity in your current property can help you avoid this.

Making use of cash now

Accessing equity unlocks your ability to pay for a property here and now, which you might not have otherwise been able to afford.

Improving your terms

If you’re looking to refinance your home loan to buy a second property, switching to a different option can save you a significant amount over both loan periods if you find the right one.

CONS

Your properties become linked

Because the equity being used to finance your new property comes from your old one, meaning that your decisions on one property may now affect the other in some way.

Increased repayments

Taking out a lump sum in equity will also add a lump back onto your existing debts, expanding the amount you’ll have to pay back for each instalment. However, this will be at least partially offset by rental income to alleviate financial pressure.

Other questions you might have about using equity to buy investment property

Should I use all of my useable equity to buy my investment property?

It depends on your personal circumstances, but probably not – it’s not always wise to immediately move to the most expensive property you can realistically afford. If it’s a sensible move considering your healthy finances and the amount you stand to benefit from it, you can consider drawing more equity. Saving equity and other funds where possible could help you cover for potential property value decreases, as well as any unexpected costs into the future, like medical bills.

How do I maximise my chances of being approved to use my home equity?

The first, and most important, indicator that lenders will look to is your credit score and financial history. If you’re making prompt, regular repayments on your home loan, your credit score will increase over time. Most lenders will consider your application more closely with a score in the “good” range (between approximately 650 and 750) but it’s always worth aiming as high as possible. Otherwise, it’s advisable to enter the application process with a clear idea in mind of what you want and why and to have reviewed the lender’s criteria closely to ensure that you qualify.

What is negative gearing and how can it affect my investment property?

Negative gearing is the idea that an asset’s expenses outweigh the income earned from it. In investment property terms, the rental income you receive wouldn’t cover your mortgage repayments and other costs if it’s negatively geared. Investors who negatively gear their properties are essentially waiting for them to increase in value enough to sell for a profit. It can also allow you to claim some of your losses on tax. However, you have to be prepared for the relative short-term pain of making a loss on your property every repayment.

Can I get pre-approval for my investment property funded with home equity?

Yes – pre-approval is often a good way for borrowers looking to use their equity to see whether their lender will accept the loan terms that they’re after before committing to a deposit. It’s a non-binding agreement, though, so it doesn’t always mean that you’ll be approved even if you gain pre-approval.

Should I apply for an interest only home loan when buying a second property?

Many investors will plump for an interest only home loan when buying investment property, as its low early repayments generally free up funds for the first one to five years of the home loan. It’s important to bear in mind that your repayments will go up and include both principal and interest after this period, which will also increase the amount you’ll pay over the loan. It’s only intended to be a short-term solution to potential cash flow issues, though.

Who should I go to for advice about buying investment property using equity?

A mortgage broker is a potential option for you to consider when tossing up whether to buy another property. They can also potentially help you secure a better deal on your home loan thanks to their established connections with lenders. You should also discuss with your accountant, or an accountant if you don’t have one already, as they’re qualified to pore over your finances and determine whether it’s a suitable move for you.