How to buy an investment property with equity

Buying an investment property is a terrific way to grow your wealth and safeguard your family’s future, which might explain why 2.2 million Australians own one.

While you will still most likely need a 20% cash deposit to secure a mortgage for it, you may be able to use the equity in your home (or other properties you own) to do so.

Equity is the difference between your property’s current market value and how much you still owe on your existing home loan repayment, and this amount can be leveraged to purchase an investment property. Here’s how.

Determine your current equity

Start by determining your current equity. The easiest way to calculate the total amount of equity you can use for buying an investment property is through this simple equation:

Property Value - Loan Balance = Equity

For example, if your home is worth $600,000 and you owe $300,000, your total equity is $300,000.

However, it is more important to understand what your usable equity is, i.e. the amount you can realistically borrow against the 80% loan to value ratio (LVR) rule enforced by banks.

In this case, your usable equity is $180,000.:

• 80% LVR of $600,000 property value = $480,000
• $480,000 - the $300,000 still owed on the mortgage = $180,000

Assess your financial position

After determining your total usable equity, the next step is to assess your financial situation.

Invoking the ‘Rule of Four’ (i.e. 4 x usable equity) is a good starting point to establish a maximum price for your investment loan.

For example, with $180,000, your equity to buy could potentially enable you to borrow $720,000. However, to gain a clearer picture, you should seek personalised, professional financial advice.

Here are other factors your bank is likely to consider:

• Stability of your job/income
• Bank account saving
• Your everyday costs and financial commitments
• Your credit score
• The amount you owe in debts, loans or credit cards
• The cost of funding two home loans and property costs, including rates, insurance, and maintenance

Explore your loan options

If investing in property, you will need to consider your loan options, one of which is refinancing. This replaces your current loan with a new one that allows you to access your equity, sometimes with better rates or terms.

Alternatively, try securing a line of credit that will enable you to withdraw funds as you need them, deposit bonds, or employ the cross-collateralisation tactic of using your multiple properties as security. However, this carries a high risk if they drop in value.

Use mortgage brokers or online tools to compare lenders and help you find the best rates and terms.

Get pre-approved for a loan

When buying any property, it is always good to secure a loan pre-approval. Doing so puts you in a much stronger negotiating position because you have the finances in place to automatically proceed to sale once your offer has been accepted.

During the application process, you will need to submit financial details like pay slips, credit history, and debt information to the lender, who will assess your suitability for pre-approval.

If granted, it could give you a competitive edge. Particularly if you are one of two buyers who make offers on their house, and the other party has no such agreement.

Using a mortgage broker to assist with your pre-approval process is highly recommended as they have access to over 60 lenders in order to the tailor the right solution. Certain lenders are better placed for self employed, whilst others for high bonus/commission earners and more complex structures. Therefore a mortgage broker can navigate this to ensure maximum borrowing capacity is derived along with the most competitive rate. Furthermore if you do not have access to the 20% then you should be able to borrow up to 95% with some lenders including LMI.

This would therefore require a cash contribution of approximately 12% including stamp duty (5% plus LMI plus stamp).

We have access to lenders that will allow certain professions (Dr, lawyer, solicitor, accountant and even frontline workers) to borrow up to 90% without LMI.

And for some special specialist medical – can stretch up to 95% without LMI.

LMI is capitalised into the loan – meaning this is borrowed and paid off over the course of the loan. LMI is a one off insurance premium.

Another option to avoid LMI is to use a security guarantor (such as parental guarantor) whereby the applicants parents provide their property as security to avoid the LMI charge.

Note if LMI is required in the loan - then this can impact the interest rate and increase the rate and repayments

Find and purchase your investment property

It is important to perform due diligence and thorough market research when searching for an investment property because a well-researched investment can generate strong returns.

This should involve assessing suburb locations, rental demand, and historical housing price trends and, of course, viewing houses, which a residential sales agent can arrange for you.

When you find one you like, you will need to put in a competitive offer; if accepted, this is when the settlement process begins. This process involves finalising financing, conducting inspections, and completing legal paperwork. Come settlement day, ownership transfers to you, and you receive the keys.

How can you increase equity?

If you increase your total home equity, you could potentially borrow more money to buy another property. Here are four strategies to consider.

1. Renovate

A good starting point is to complete upgrades that would immediately boost the value of your home. This can include creating a more modern kitchen by replacing outdated cabinetry and benchtops with something that has a wow factor.

2. Increase the floorplan

Another excellent way to boost your equity is to build an extension, conservatory, swimming pool, or extra bedroom. Doing this may add significant value to your home, although it's worth checking with a real estate agent first.

3. Subdivide or develop

If you live on a large block of land and the local council zoning allows it, you might benefit from either splitting it into two distinct lots and selling one or adding a second dwelling onto it to rent it out.

4. Make extra mortgage payments

The less of a mortgage you have, the higher your equity will be to buy property. It is a good idea to make extra payments on your mortgage. Simply making a $100 overpayment every week will shave $5,200 off your total loan balance annually.

Considerations before using equity for property investment

Accessing your equity might be an attractive option. But there are a few things you should consider carefully before doing so.

1. Market fluctuations

Property values can rise or fall over time, so if the market dips, your equity may shrink. This might affect your borrowing power.

2. Interest rate changes

Since 1990, the RBA cash rate has repeatedly risen and fallen. Therefore, taking out a fixed-rate loan might be a more attractive option than variable loans.

3. Vacancy periods

Unless you can find a reliable long-term renter, there will be times when your property is untenanted.

Subsequently, it is wise to budget for gaps in rental income to avoid being caught off guard.

4. Tax implications

It is a good idea to seek professional advice from an accountant about tax benefits, such as deductible interest, and the implications of capital gains tax deductions and negative gearing.

Summing up

Tapping into the equity of your current home or other dwellings you own can be an excellent way to buy investment property. However, you should carefully weigh up whether it is the right move for you before committing to doing so.

If you want to increase the amount of equity you have at your disposal, our property managers can advise on the best ways to add value to your home.

We can help you find the perfect investment property for your needs – contact us today.

FAQs

How can I use home equity to buy an investment property?

If your home is valued higher than your remaining loan balance, you can leverage equity to invest. While a home lending specialist can help determine loan amounts based on your financial situation, lenders typically allow you to access a portion of this equity as a loan top-up or separate loan.

What costs should I consider when using equity to purchase property?

Buying costs include stamp duty, lenders mortgage insurance (if borrowing over 80% of the property value), fees and charges for loans and finance, and home and contents insurance.

Should I seek independent tax advice before property investing?

Yes. Tax implications vary based on your investment strategies, so it is best to talk to a financial adviser who can guide you on things like deductible interest, capital gains tax, and using offset accounts to manage cash flow.