Using Equity to Buy an Investment Property in Australia: A Step-by-Step Guide

Using the equity in your home to purchase an investment property is a popular wealth-building strategy in Australia. By leveraging the value you’ve built in your current property, you can expand your portfolio without needing a large cash deposit. This guide walks you through the process, from understanding equity to navigating lender requirements and tax considerations.

What Is Home Equity and How Can You Use It?

Home equity is the difference between your property’s current market value and the outstanding balance on your mortgage. For example, if your home is worth $800,000 and you owe $400,000, your equity is $400,000. However, lenders typically allow you to borrow only a portion of this—usually up to 80% of the property’s value, minus any existing debt. This is known as usable equity.

Using equity means you borrow against your existing home to fund the deposit, and sometimes the costs, of an investment property. This approach can help you avoid saving for years for a cash deposit and potentially enter the property market sooner.

Step 1: Calculate Your Usable Equity

Before approaching a lender, you need to know how much equity you can access. The calculation is straightforward:

1. Determine your home’s current market value. You can get a professional appraisal or use recent comparable sales in your area.
2. Find out your outstanding loan balance.
3. Calculate 80% of the property’s value.
4. Subtract your loan balance from that 80% figure.

Example:

This $320,000 could be used as a deposit for an investment property. However, lenders will also assess your ability to service the new debt, which we’ll cover later.

Step 2: Understand Lender Requirements

Lenders have specific criteria when you apply for an equity release or a new investment loan. Here are the key factors they consider:

Loan-to-Value Ratio (LVR)

Most lenders cap the LVR at 80% when using equity, meaning you can borrow up to 80% of your home’s value without paying Lenders Mortgage Insurance (LMI). If you go above 80%, LMI applies, which can add thousands to your costs. Some lenders may allow up to 90% LVR for investment loans, but this is riskier and more expensive.

Serviceability

Lenders will assess your income, expenses, and existing debts to ensure you can afford the new loan repayments. They typically add a buffer of 3% to the loan’s interest rate to test affordability. Rental income from the investment property is usually considered, but often at only 75-80% of the expected rent to account for vacancies and expenses.

Credit History

A clean credit report is essential. Any defaults, late payments, or high credit card limits can reduce your borrowing capacity.

Property Type and Location

Lenders may have restrictions on certain property types (e.g., studio apartments, rural properties) or locations. It’s wise to check with a mortgage broker about specific lender policies.

Step 3: Structuring Your Loans

How you structure your loans can impact your tax deductions and financial flexibility. Common structures include:

Cross-Collateralisation

This is where the lender secures both properties under one loan. While it may simplify the process, it reduces flexibility—if you want to sell one property, you may need the lender’s permission, and they could revalue both properties.

Separate Loans with Equity Release

A better approach is often to establish a separate loan for the investment property, using an equity release from your home as the deposit. This keeps the properties unlinked, and the investment loan interest is fully tax-deductible.

Example structure:

1. Keep your existing home loan as is.
2. Apply for a new loan or increase on your home loan (equity release) to access the usable equity.
3. Use those funds as a deposit for the investment property.
4. Take out a separate investment loan for the remaining purchase price.

This separation is crucial for tax purposes, as only the interest on the investment loan is deductible.

Step 4: Tax Considerations

Understanding the tax implications can help you maximise your returns and avoid costly mistakes.

Interest Deductibility

Interest on the loan used to purchase an income-producing asset is generally tax-deductible. This is why separating your loans is important—if you redraw from your home loan for personal use, that portion’s interest may not be deductible. Always use the equity release specifically for the investment property deposit.

Negative Gearing

If your rental income is less than your expenses (including interest, rates, maintenance, and depreciation), you make a loss. This loss can be offset against your other income, reducing your taxable income. Negative gearing is a common strategy in Australia, but it relies on future capital growth to be profitable.

Capital Gains Tax (CGT)

When you sell the investment property, you’ll pay CGT on the profit. If you hold the property for more than 12 months, you may be eligible for a 50% CGT discount. Keeping detailed records of all costs (purchase, improvements, selling fees) is essential to calculate your capital gain accurately.

Depreciation

You can claim tax deductions for the decline in value of the building (if built after 1987 for residential properties) and its fixtures and fittings. A quantity surveyor can prepare a tax depreciation schedule to maximise your claims.

For more detailed information on rental property deductions, visit the Australian Taxation Office website.

Step 5: Risks and How to Mitigate Them

While using equity can accelerate wealth building, it’s not without risks:

• Market downturns: If property values fall, your equity shrinks, and you may owe more than the property is worth.
• Interest rate rises: Higher rates increase your repayments, potentially causing cash flow stress.
• Vacancy periods: Without rental income, you must cover the mortgage from your own pocket.
• Over-leveraging: Borrowing too much can strain your finances if circumstances change.

Mitigation strategies:

• Maintain a cash buffer for unexpected expenses or vacancies.
• Fix interest rates for certainty, or ensure you can afford rate rises.
• Choose properties with strong rental demand.
• Avoid cross-collateralisation to retain flexibility.

Step 6: The Application Process

1. Assess your financial position: Calculate your equity, check your credit score, and review your income and expenses.
2. Get a property valuation: Your lender may arrange this, but you can also get an independent valuation.
3. Consult a mortgage broker: They can compare lenders and find the best structure for your needs.
4. Apply for pre-approval: This gives you a budget and shows agents you’re a serious buyer.
5. Find the investment property: Research high-growth areas with good rental yields.
6. Finalise the loan: Once you’ve signed a contract, the lender will complete the valuation and formal approval.
7. Settlement: Your solicitor or conveyancer handles the legal transfer.


FAQ

Can I use equity if my home is not fully paid off?

Yes, you don’t need to own your home outright. Equity is the portion you own, so as long as you have sufficient usable equity (and meet serviceability requirements), you can access it.

What costs can I cover with equity?

You can use equity to cover the deposit, stamp duty, legal fees, and even minor renovations on the investment property. However, be careful to keep the loan purpose clear for tax deductibility.

How does using equity affect my home loan repayments?

When you release equity, your home loan balance increases, so your repayments will rise. Ensure you can afford the higher repayments, especially if interest rates increase.

Is it better to use equity or save a cash deposit?

Using equity can get you into the market faster and potentially capture growth sooner. However, it increases your debt and risk. A cash deposit avoids extra interest costs but takes time to accumulate. The right choice depends on your financial goals, risk tolerance, and market conditions.

Do I need to tell my current lender I’m buying an investment property?

If you’re releasing equity from your existing home loan, you’ll need your lender’s approval. If you’re refinancing to another lender, you’ll disclose the purpose of the funds during the application.

References

1. Australian Taxation Office. (2023). Rental properties. Retrieved from https://www.ato.gov.au/individuals-and-families/investments-and-assets/rental-property
2. Australian Securities and Investments Commission. (2024). Borrowing to invest. Retrieved from https://moneysmart.gov.au/investing/borrowing-to-invest
3. Reserve Bank of Australia. (2024). Housing lending and borrowing. Retrieved from https://www.rba.gov.au/fin-stability/housing-lending.html
4. Australian Bureau of Statistics. (2023). Residential property price indexes. Retrieved from https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/residential-property-price-indexes-quarterly

Disclaimer: This article is for informational purposes only and does not constitute financial, tax, or legal advice. You should consult a qualified professional before making any investment decisions.