How to Use Equity in Your Home to Buy an Investment Property in Australia

Investing in property is a popular wealth-building strategy in Australia, but coming up with a deposit can be a major hurdle. If you already own a home, you might be sitting on a valuable asset that can help you get started: your home equity. By leveraging the equity in your existing property, you can fund the deposit for an investment property without needing to save a large cash sum. This guide walks you through the process step by step, covering everything from how equity works to loan structures, tax implications, and lender requirements.


What Is Home Equity and How Does It Work?

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, not all of this equity is usable. Lenders typically allow you to borrow up to 80% of the property’s value (loan-to-value ratio, or LVR) for investment purposes, minus any existing debt. This usable portion is often called “accessible equity.”

Calculating Your Usable Equity

To determine how much equity you can access, follow these steps:

1. Estimate your property’s current market value. You can use recent sales data, a professional appraisal, or a lender’s valuation.
2. Calculate 80% of that value. This is the maximum total borrowing against the property.
3. Subtract your current mortgage balance. The result is your accessible equity.

For instance, using the numbers above: 80% of $800,000 is $640,000. Minus the $400,000 mortgage leaves $240,000 in usable equity. This amount can serve as a deposit for an investment property, potentially covering the full 20% deposit plus purchase costs like stamp duty.

Step-by-Step Guide to Using Equity for an Investment Property

Step 1: Assess Your Financial Position

Before approaching a lender, review your finances thoroughly. Lenders will assess your income, expenses, existing debts, and credit history. Key factors include:

• Stable employment and income: Lenders prefer borrowers with a consistent job history and sufficient income to service two loans.
• Credit score: A strong credit score improves your chances of approval and may secure better interest rates.
• Debt-to-income ratio: Keep other debts low to demonstrate you can handle additional borrowing.

Step 2: Get a Property Valuation

A formal valuation is essential because lenders will use it to determine your usable equity. You can order a valuation through a lender or an independent valuer. The valuation may come in lower than market expectations, so it’s wise to be conservative in your estimates.

Step 3: Understand Loan Structures

There are two primary ways to access equity:

• Equity release (cash-out refinance): You refinance your existing home loan and borrow additional funds against the equity. The extra amount is placed in a separate account or loan split, which you then use as the deposit for the investment property.
• Line of credit: A revolving credit facility secured against your home, allowing you to draw funds as needed. This offers flexibility but may have higher interest rates.

Most investors opt for an equity release via a loan split because it keeps the investment deposit separate from personal debt, which is beneficial for tax purposes (see Section on Tax Considerations).

Step 4: Choose the Right Investment Property Loan

When buying the investment property, you’ll need a separate loan. Common options include:

• Principal and interest (P&I) loan: You pay down both interest and principal, building equity in the investment property over time.
• Interest-only (IO) loan: You pay only the interest for a set period (usually 1–5 years), which can maximise tax deductions and improve cash flow. However, IO loans typically revert to P&I after the interest-only period, leading to higher repayments.

Lenders often view interest-only loans as riskier, so they may require a higher deposit or charge a higher interest rate.

Step 5: Apply for Pre-approval and Make an Offer

With your equity release arranged, apply for pre-approval on the investment loan. Once pre-approved, you can confidently search for a property within your budget. After finding a suitable property, finalise the loan application and proceed to settlement.

Lender Requirements and LVR Limits

Lenders have specific criteria when using equity for an investment property. Here’s what you need to know:

Loan-to-Value Ratio (LVR) Caps

Most lenders cap the LVR at 80% for equity releases, meaning you can borrow up to 80% of your home’s value minus the existing mortgage. Some lenders may go up to 90%, but this usually requires Lenders Mortgage Insurance (LMI), which can be costly.

Serviceability Assessment

Lenders will stress-test your ability to repay both loans. They apply a buffer (typically 3% above the loan’s interest rate) to ensure you can handle rate rises. They also consider:

• Rental income from the investment property (usually shaded to 75–80% to account for vacancies and expenses)
• Negative gearing benefits (though not all lenders factor this in)
• Living expenses based on the Household Expenditure Measure (HEM) or your declared spending

Cross-collateralisation vs. Standalone Loans

When using equity, you may be offered cross-collateralisation, where both properties secure both loans. This can simplify the process but ties the properties together, reducing flexibility if you want to sell one later. A standalone structure, where each property secures its own loan, is often preferred for asset protection and tax efficiency.

Documentation Required

Be prepared to provide:

• Recent payslips and employment contract
• Tax returns and notices of assessment (if self-employed)
• Bank statements showing savings and spending patterns
• Identification documents
• Details of existing debts and assets

Tax Considerations

Using equity for investment can have significant tax implications. The key principle is that the purpose of the borrowed funds determines deductibility.

Deductibility of Interest

Interest on the portion of the loan used to buy an income-producing asset (the investment property) is tax-deductible. However, if you use the equity for personal purposes, the interest is not deductible. This is why structuring the loan correctly is crucial.

Example: You release $200,000 equity and use $150,000 as a deposit for an investment property. The interest on that $150,000 is deductible. If you use the remaining $50,000 for a holiday, that portion’s interest is not deductible. To avoid contamination, split the loan so the investment portion is clearly separate.

Negative Gearing

If the investment property’s expenses (including interest, maintenance, and depreciation) exceed its rental income, you make a loss. This loss can be offset against your other assessable income, reducing your tax bill. Negative gearing is a common strategy, but it relies on future capital growth to be profitable.

Capital Gains Tax (CGT)

When you sell the investment property, you’ll be liable for CGT on the profit. However, if you hold the property for more than 12 months, you may be eligible for a 50% CGT discount. Keep detailed records of all costs associated with the purchase, improvements, and sale to accurately calculate your capital gain.

Depreciation

Investment properties can generate tax deductions through depreciation of the building structure and plant and equipment (like appliances and carpets). A quantity surveyor can prepare a tax depreciation schedule to maximise your claims.

Always consult a qualified tax professional to tailor these strategies to your circumstances.

Risks and How to Mitigate Them

Leveraging equity magnifies both gains and losses. Be aware of these risks:

• Property market downturns: Falling values can reduce your equity and may lead to negative equity if you’ve borrowed heavily.
• Interest rate rises: Higher rates increase repayments on both loans, potentially straining your cash flow.
• Vacancy periods: If your investment property is untenanted, you must cover the mortgage without rental income.
• Overcapitalisation: Spending too much on the investment property relative to its market value can erode returns.

Mitigation Strategies

• Maintain a cash buffer for unexpected expenses or vacancies.
• Fix interest rates on a portion of your debt to protect against rate hikes.
• Choose properties in high-demand rental areas with low vacancy rates.
• Avoid borrowing to your maximum capacity; leave headroom for rate increases.

Comparison: Equity Release vs. Saving a Cash Deposit

Case Study: The Smiths’ Equity Journey

John and Sarah Smith own a home in Melbourne valued at $900,000 with a mortgage of $350,000. They want to buy an investment property worth $600,000.

1. Usable equity calculation: 80% of $900,000 = $720,000. Minus $350,000 mortgage = $370,000 usable equity.
2. Equity release: They refinance their home loan, increasing it to $720,000 and placing the extra $370,000 in a separate loan split.
3. Deposit and costs: They use $120,000 (20% deposit) plus $30,000 for stamp duty and fees, leaving $220,000 in the offset account as a buffer.
4. Investment loan: They take out a $480,000 interest-only loan for the investment property at 6.5% p.a.
5. Tax outcome: Interest on the $120,000 deposit portion is deductible. Rental income covers most of the interest, and they claim depreciation, resulting in a small negative gearing benefit.

By using equity, the Smiths entered the investment market years earlier than if they had saved the deposit.

FAQ

Can I use equity if I have a low income?

Lenders assess serviceability strictly. If your income is low, you may not qualify for the additional debt, even if you have significant equity. Consider reducing other debts or increasing your income before applying.

Is it better to use equity or a cash deposit?

Using equity can accelerate your investment timeline, but it increases your overall debt and risk. A cash deposit avoids additional borrowing against your home but may delay your purchase. The right choice depends on your risk tolerance, financial goals, and market conditions.

What if my property value drops after I release equity?

A market downturn can reduce your equity and potentially push your LVR above 80%, triggering LMI or making refinancing difficult. Maintaining a buffer and not borrowing the maximum can help cushion against value falls.

Can I use equity to buy a property in a different state?

Yes, equity released from your home can be used to purchase an investment property anywhere in Australia. However, be aware of different state stamp duty rules and property market dynamics.

How long does the equity release process take?

Typically, it takes 4–8 weeks from application to settlement, depending on the lender and complexity of your financial situation. Having your documents ready can speed up the process.

References

1. Australian Taxation Office, “Rental properties – claiming interest on loans,” 2024. https://www.ato.gov.au/individuals-and-families/investments-and-assets/rental-properties/rental-properties---claiming-interest-on-loans
2. Australian Securities and Investments Commission, “Home loans: using equity,” 2024. https://moneysmart.gov.au/home-loans/using-equity
3. Reserve Bank of Australia, “Statement on Monetary Policy – Box B: Household Equity and Housing Market Conditions,” May 2024. https://www.rba.gov.au/publications/smp/2024/may/box-b-household-equity-and-housing-market-conditions.html
4. Australian Prudential Regulation Authority, “APRA releases quarterly authorised deposit-taking institution statistics for December 2023,” February 2024. https://www.apra.gov.au/news-and-publications/apra-releases-quarterly-authorised-deposit-taking-institution-statistics-for-december-2023
5. CoreLogic, “Housing Market Update: Australian dwelling values rise 8.1% over 2023 calendar year,” January 2024. https://www.corelogic.com.au/news-research/news/2024/housing-market-update-australian-dwelling-values-rise-8.1-over-2023-calendar-year