How to use equity to buy investment property

If you've been paying off your home loan for some time, chances are you've built up equity in your property. In a booming housing market, your equity could have significantly increased, presenting you with new financial opportunities, such as borrowing against your equity to invest in additional properties, renovate, or achieve other financial goals.

Depending on how long you’ve owned your home, you may be sitting on a pot of gold when it comes to the amount of home equity that you could access.

We will explore the ins and outs of buying an investment property with a home equity loan, informing you on the steps to begin building a property portfolio.

Before we go further, let’s grasp the concept of what equity actually means. 

What is home equity?

Simply put, a home equity loan works by allowing you, the homeowner, to borrow money against the value of your home. You access this equity by using your home as collateral.  Before you do anything, a property valuation is crucial to ensure you know your properties current market value to assist with refinancing and borrowing.  

As a homeowner, if your property has appreciated since the time of purchase, the increased market value contributes to the growth of your home equity. Fluctuations in the real estate market can also impact your equity position, so staying up to date on your property's value is essential.

The calculation to work out your equity is straightforward: subtract your outstanding mortgage balance from your property's current market value.

For example, if your home is valued at $500,000 and your outstanding mortgage debt is $320,000, your equity amounts to $180,000.

By tapping into the equity built in your existing home, you can potentially refinance your mortgage and release additional funds to invest in your next property.

So, how much can you borrow?

Remember: The Rule of Four

Take your useable equity and multiply by four for a maximum purchase price for your investment property. 

You will also need to factor in additional costs of purchasing a property, so add an additional 5% of the purchase price to cover things like stamp duty and legal fees. For an investment property valued at $500,000, this will be $25,000.

Investment Property vs Second Home

An investment property is something you purchase to generate income, as opposed to a second home that you intend to use on a regular basis for at least 12 months.

Investment properties generate rental income when occupied by tenants, and can increase in value over time, while also providing tax benefits in some cases.

Considerations before diving in

Before leveraging your home equity for an investment property, it's important to weigh the risks and rewards carefully. Consider factors such as interest rates, repayment obligations, market conditions, and your financial situation.

It is also worth noting that your total equity is not the same as useable equity. Banks generally will not take the risk of allowing you to use your entire equity, instead offering to loan 80% of your total equity. This is to protect you (and the bank) against a substantial fall in property value that may leave you with a loan that’s worth more than the property.

Some banks will allow you to borrow more than 80% if you take out Mortgage Lenders Insurance (LMI).

What deposit is required for your next property?

Leveraging home equity reduces the need for a substantial deposit on your next property. Using your existing equity as a down payment can potentially secure favourable financing terms and expedite the purchase process.

Refinancing means changing your current mortgage, often to get better terms and tap into your home equity for investing in another property and expanding your portfolio.

How long does it take to build equity?

Patience is key when buying an investment property with equity. The timeline varies based on factors such as your mortgage repayment schedule, property appreciation rates, additional contributions towards paying off the mortgage and obtaining an accurate property valuation to assess your home’s market value.

Conclusion

A home equity loan could unlock the door to future investment property opportunities, and your current home might hold the key to realising your property investment dreams.

When navigating the realm of home equity, consulting with your home mortgage provider is crucial. Your mortgage provider can offer invaluable insights into your equity position, financing options, and potential risks of leveraging home equity for investment property purposes.

So, if you've been looking into investment property opportunities, it may be time to have a chat with your mortgage broker to get the ball rolling. Happy investing! 

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