Property News & Insights

APU - Australian Property Update | Leveraging Equity to Buy Investment Property

Written by Scott Kuru | Dec 28, 2023 3:06:32 PM

As house prices increase, it becomes more and more difficult to save enough money to have a deposit for your next property investment. 

 

However, there is one very useful way that can accelerate your portfolio growth — if you know how. As your property value increases through normal market growth, you can actually access that equity and use it as a deposit (or part of a deposit) to purchase another property and expand your portfolio. 

 

Understanding home equity

First of all, let's define ‘equity.' Simply put, equity is the difference between your property's current market value and the outstanding balance on your mortgage. For example, if you have property valued at $500,000, and you have a mortgage of $300,000, you have $200,000 in equity. 

 

 

Some lenders will actually let you borrow some (but not all) of that equity as the deposit. This is called usable equity. Leveraging usable equity can provide a substantial boost to finance your next property investment without immediate cash outlay. 

 

Banks typically lend up to 80% of your home's value minus the existing mortgage. In this case, that would be 80% of $500,000, which is $400,000, minus the $300,000 mortgage, leaving a potential borrowing amount of $100,000. This amount can significantly aid in financing your next property investment, offering a means to leverage your assets without requiring immediate cash.

 

 

Other ways to bring that equity to use

 

As well as funding property investments, equity can cover education expenses, medical bills, or refinance existing loans for better rates, unlocking further equity. There are, in fact, many different ways banks allow you to use equity. 

 

Not only can you use equity to leverage more finance for investment, but you may be able to avoid Lenders Mortgage Insurance (LMI), a hefty cost that can exceed $20,000. Using equity strategically can bypass this expense.

 

You can also consider using equity for a Home Loan Top-up. If the value of your investment property increases, you can tap into this equity to pay off your existing home loan. The benefit of doing this is that interest payments on investment properties are tax-deductible, unlike the payments on your primary residence.

 

A supplementary loan account offers another way to leverage your home's equity for specific goals like renovations or property investment. Offering lower interest rates and higher borrowing limits than personal loans allows flexible fund usage. However, it requires careful financial assessment due to associated fees and potentially higher rates.

 

Cross collateralisation secures loans using multiple properties as collateral, often for acquiring more investments. Linking the equity of various assets, this method offers larger loan amounts due to the combined property values. Typically yielding lower interest rates, it enables leveraging multiple properties.

Important considerations

 

Both supplementary loan accounts and cross-collateralisation often incur higher interest rates for loans of more than 80% of the property value, mandatory LMI, and additional fees. But by far the biggest risk is that of property loss—your home in supplementary loans, and multiple properties with cross collateralisation.

 

The 'Rule of Four' is a prudent approach to leveraging equity, ensuring balanced financial decisions. 

 

This method involves a comprehensive evaluation starting with income stability. Lenders place significant emphasis on this, as it directly influences your borrowing capacity. 

 

In addition to income, lenders also meticulously examine your existing debts. This analysis is key in determining your financial health and gauging your capacity for additional borrowing. 

 

Another crucial element of this rule is the maintenance of a rainy day fund. Leveraging equity effectively requires not using all available equity, as doing so can leave you financially vulnerable. A reserve fund is essential, providing a buffer for unforeseen expenses or emergencies.

 

Lastly, understanding the tax implications of equity investments is an integral part of this strategy. It’s important to recognise how using equity can affect your tax situation, including eligibility for deductions and its overall impact on your tax liability. 

 

Remember, property investment should align with your long-term goals. Be mindful of risks, maintain a contingency fund, and understand the tax benefits. Choosing the right loan type, like interest-only options, might be beneficial, but seek professional advice.

 

Leveraging home equity for property investment offers a pathway to expand your portfolio. It requires careful planning, an understanding of financial products, and a keen eye on market trends. Done wisely, it can be a game-changer in your investment journey.