Using equity to buy another house is something many homeowners dream about. But is owning an investment property beyond the reach of the average Australian? Is it only achievable for the top 1%? You may feel like you struggled and saved for years just to purchase your first home, so how on earth will you afford a second one?! If you feel like this, don’t give up! Using equity to buy an investment property may be more achievable than you think.
According to the latest statistics from the Australian Taxation Office (ATO), over 2.24 million Australians owned an investment property in 2020-2021. That’s around 1 in 5, or 20% of Australian taxpayers. So, owning an investment property is clearly an achievable goal. How do many achieve this? By using the equity in the current property to help finance their investment.
Using Equity to Buy Another House
What does using equity to buy an investment property involve? It’s when you leverage the value of a property you already own to help finance the purchase of a new one. This can be done when the balance of your existing home loan is less than the property’s current market value. Borrowing against the equity can help potential investors who wouldn’t otherwise have the savings needed to secure a second mortgage. Using equity to buy another house comes with potential risks and benefits, so homeowners need a clear understanding of what’s involved before going ahead with an investment purchase.
Using Equity to Buy Another House – Understanding the Jargon
If you’ve started researching how to use equity to buy an investment property, you’ve probably already come across a lot of unfamiliar financial jargon. An accurate understanding of this terminology will be really beneficial if you decide to move ahead with accessing equity. Some of the most common terms you’ll come across are:
- Equity: The portion of property ownership that is not covered by a home loan. In other words, the part you have paid off and now own outright.
- Usable Equity: The portion of a property’s value that can be borrowed against. This is usually calculated by taking 80% of the overall value of the property and then subtracting the outstanding mortgage total.
- Home Loan Refinance: When you replace an existing mortgage with a new one, often to secure better terms, rates or conditions. This can also be done to access equity.
- Leveraging: When you use the existing property’s equity as collateral to secure a loan for purchasing an additional property.
- Loan to Value Ratio (LVR): A calculation used by lenders. It represents the percentage of the loan amount compared to the property’s appraised value. The lower the LVR, the less risky the loan is considered by lenders.
- Capital Growth: The increase in a property’s value over time, which can boost the amount of equity you have.
- Negative Gearing: When the costs of owning a rental property (maintenance, home loan interest, etc.) are more than the income generated by renting the property out.
How to Use Equity to Buy an Investment Property
So, you want to use the equity in your current home to buy another house. How do you go about calculating how much equity you have?
Start by obtaining an accurate assessment of your property’s current market value. Then, deduct the balance of your existing home loan. The remaining value is your total equity. For example, if your home is valued at $750,000 and you owe $350,000 on your mortgage, that means your current equity amount is $400,000. Most lenders will then lend a percentage of that equity (the ‘usable equity’) to you, which you can put towards buying another property.
How Much Do I Need If I’m Using Equity to Buy Another House?
Using equity to buy another house is possible if you have enough of a ‘usable equity’ buffer. Generally, lenders are happy to lend up to 80% of a home’s value (that includes your current debt as well) without requiring Lenders Mortgage Insurance (LMI). This means your usable equity is 80% of your home’s current value, minus any existing debt.
With the numbers we used above, your usable equity would look like this:
- $750,000 (home value) x 80% = $600,000
- $600,000 (80% of home value) – $350,000 (current mortgage balance) = $250,000
In this scenario, your usable equity would be calculated at $250,000.
How Much Can I Borrow If I’m Using Equity to Buy an Investment Property?
Similar to when you bought your first home, most banks are willing to lend up to 80% of your investment property’s value with a home loan. They may loan you more if you’re willing to pay for LMI.
Once you know how much usable equity you have in your current home, you can work out roughly how much you could borrow to secure an investment property. You can do this by multiplying your usable equity by 5. If we continue using the figures from the example above, the calculation will look like this:
- $250,000 (usable equity) x 5 = $1,250,000
Using equity as a deposit in this scenario means with your usable equity of $250,000, you have a 20% deposit to find a home worth more than $1 million.
Your capacity to buy a $1 million property also needs to factor in costs of stamp duty, legal fees and other upfront costs, as well as your ability to make repayments. That’s why it’s important to speak to an experienced mortgage broker who can assist you in better understanding your financial situation.
How to Use Equity to Buy Additional Investment Properties
If you have a principal and interest home loan on your investment property it will gradually start building up equity too. Property values rising on both your owner-occupied home and your investment property will increase your overall equity. As you build usable equity across your two properties, you can potentially draw on it as leverage to purchase more investment properties in the future (if that is your goal).
Property wealth is impacted by market prices because that determines your home’s value (and therefore, usable equity). So, as markets rise, your property wealth grows, and each time it falls, your property wealth shrinks. If you are strategic with your real estate portfolio, you can use it to your advantage to achieve long-term wealth.
What are the Potential Risks of Using Equity to Buy Another House?
There are certain risks associated with using equity to buy an investment property. These include:
- Market Volatility: Australia’s property market can be volatile. If there’s a market downturn, you could end up with multiple properties that are worth less than what you paid for them.
- Interest Costs: Taking on a second home loan means you’ll be managing additional interest costs, which can lead to strain on your monthly budget.
- Loan Approval: Securing approval for a second mortgage can be challenging because lending criteria is often quite strict.
- Reduced Home Equity: Using the equity from your primary property can limit your ability to access it for other financial needs (such as future renovations) or emergencies.
- Negative Gearing: If the new property doesn’t generate enough rental income to cover expenses, you may have to deal with negative gearing. While this can lead to tax deductions, it can also create financial stress.
- Responsibilities: Owning multiple properties comes with added responsibilities. In addition to looking after your family home, you’ll also need to deal with property management, maintenance and any tenant issues.
While the above list may seem daunting, many of these risks can be managed by doing thorough research and consulting with experts before making a purchase.
What are the Advantages of Using Equity to Buy Another House?
There are significant advantages associated with using equity to buy an investment property. These include:
- Leverage: Australia’s strong property market and consistent price growth make it an attractive environment for leveraging your existing property’s equity to purchase a new one.
- Rental Income: You can generate consistent rental income from the new property, especially in high-demand areas. This can help to offset your expenses.
- Tax Benefits: Home loan interest on the new property may be tax-deductible, potentially reducing your overall tax liability (talk to a financial consultant for more information on how an investment property will affect your tax).
- Capital Growth: Historically, Australian property has seen steady capital growth. As a result, owning multiple properties can produce long-term financial benefits.
- Diversification: Owning multiple properties in different regions (or investing in different types of real estate) can diversify your investments and reduce risk.
Using equity to buy an investment property carries the potential for substantial benefits. A mortgage broker with experience in investment loans can help you make the most of your assets to help you achieve your long-term financial goals.
Talk to a Mortgage Broker About How to Use Equity to Buy an Investment Property
Whatever your financial and property goals, talking to an experienced mortgage broker should always be your first step. This will help you to gain a better understanding of what is possible when using equity to buy an investment property.
As experts in investment property mortgages, the team at Sunshine Coast Financial Solutions can guide you through the process of using equity to buy another house. Contact us today to book an appointment where you can find out more.
