Using equity to buy an investment property is something many established homeowners consider once their home loan has reduced or the property has increased in value.
On paper, the idea sounds fairly simple: you have equity in your home, you release some of it and use that towards the deposit and purchase costs for an investment property.
In practice, there are a few more moving parts.
The amount of equity sitting in a property is not necessarily the amount that can be accessed, and having available equity does not automatically mean there is enough borrowing capacity to complete the next purchase.
What Does Using Equity to Buy an Investment Property Mean?
Equity is the difference between what a property is worth and what is currently owed against it.
For example, if your home is worth $1.8 million and the home loan is $800,000, there is $1 million in equity on paper.
That does not mean the bank will allow the full $1 million to be released.
The lender will have limits around how much they are prepared to lend against the property and will also assess whether the household income can support the additional debt.
This is why total equity and usable equity are not the same thing.
How Much Equity Can You Actually Use?
The amount of equity that may be available depends on factors including:
- The current property value
- The existing loan balance
- The lender’s maximum loan-to-value ratio
- Whether mortgage insurance applies
- The purpose of the additional borrowing
- Overall borrowing capacity
A homeowner may have substantial equity in the property but still be unable to access all of it.
Before looking seriously at an investment purchase, it can be useful to establish how much equity may realistically be available and what level of purchase that could support.
Equity Can Help Fund the Deposit and Purchase Costs
For many investors, using equity reduces the amount of cash that needs to be contributed towards the next purchase.
A separate equity loan may potentially help fund costs such as:
- The deposit
- Stamp duty
- Legal costs
- Other purchase costs
The investment property itself would then generally have its own separate loan.
This can allow more cash to remain available rather than using all available savings to complete the transaction.
However, using as much equity as possible is not necessarily the goal. It is also worth considering how much cash and equity will remain after settlement.
Borrowing Capacity Still Matters
Having plenty of equity does not automatically mean you can borrow enough to purchase another property.
The lender still needs to assess whether the income can support the total debt after the purchase.
That assessment can include the existing home loan, other investment debt, credit cards, car finance, household expenses and the proposed investment loan. The lender will also assess the expected rental income from the new property.
This is why someone can have substantial equity available but still be limited by borrowing capacity.
Related: Borrowing Capacity for Your Next Property: What Can You Actually Afford?
Keep the Equity Loan Separate
Where equity from a home is being used for an investment purchase, keeping that borrowing in a separate loan split can make the structure much clearer.
For example, the lending might consist of:
- The existing home loan
- A separate equity split for the investment deposit and purchase costs
- A separate loan secured by the new investment property
This helps keep the purpose of each loan easier to identify and avoids unnecessarily mixing personal and investment borrowing together.
The tax treatment of interest and deductibility should always be confirmed with an accountant or tax adviser. From a lending perspective, keeping the purpose of each loan clear generally makes the structure easier to manage.
Do You Need to Use Your Current Bank?
Not necessarily.
A common assumption is that because the equity is held against the current home, the entire transaction needs to remain with the same lender.
Sometimes that will be the most suitable option.
In other cases, the existing lender may be competitive on the home loan but provide a less suitable borrowing result for the investment purchase.
Another lender may assess income, rental income or existing debts differently.
There can also be situations where the existing home loan remains where it is and another lender is used for the new investment property.
The right structure depends on the overall position rather than simply which lender currently holds the home loan.
Cross-Collateralisation Is Worth Understanding
Cross-collateralisation occurs where more than one property is used as security for the lending.
For example, a lender may take both the existing home and the new investment property as security.
This can sometimes make the transaction simpler at the outset, but it can also tie the properties together.
If one property is later sold, refinanced or moved to another lender, the remaining lending may need to be reassessed.
Cross-collateralisation is not automatically a poor structure, but it is important to understand which properties are securing which loans before proceeding.
Existing Investment Loans Can Affect the Next Purchase
For someone who already owns one or more investment properties, the lender will assess the existing portfolio as part of the new application.
This is where the bank’s servicing calculation can look very different to actual monthly cash flow.
Rental income is generally shaded, meaning the lender may only use part of the rent received. Existing loans are also assessed using rates above the actual rate being paid.
Interest-only loans can have an additional impact because the lender may assess the future principal repayment over the remaining loan term.
As a result, an investment portfolio that looks comfortable from a cash-flow perspective can appear much tighter inside a lender’s servicing calculator.
Related: Why Your Existing Investment Loans Can Limit What You Borrow Next.
You Do Not Have to Use Every Dollar Available
Just because a lender is prepared to release a certain amount of equity does not mean all of it needs to be used.
It is worth considering how much is actually required for the purchase and what the financial position will look like afterwards.
That can include how much cash remains available, how much equity remains in the home and whether there is enough flexibility for vacancies, repairs or unexpected household expenses.
The lending still needs to be manageable outside the bank’s servicing calculator.
Think About What May Come Next
For someone planning to build an investment portfolio, the structure used for the first purchase can affect later borrowing.
A structure that works well for one investment property may not necessarily provide the same flexibility when buying a second or third property.
Future plans such as another investment purchase or an upgrade to the family home can therefore be relevant when deciding how the lending should be arranged today.
Work Through the Full Position Before You Buy
Using equity can be a useful way to help fund an investment property purchase, but the equity itself is only one part of the equation.
Borrowing capacity, existing debt, loan structure, available cash, lender policy and future plans can all affect what is practical.
Working through those factors before finding a property can provide a much clearer picture of the price range and lending structure that may be available.
Have a Question About Using Equity?
The amount of equity in your home and the amount that can actually be used towards another property can be very different.
Ask me a question if there is something about usable equity, borrowing capacity or the lending structure you would like clarified.