The pros and cons of using equity to purchase an investment property

An overview of the pros and cons of using equity to buy an investment property

Many homeowners choose to use their home equity to fund the purchase of an investment property. Tapping into your equity can offer a number of advantages, but it also comes with several drawbacks.

Here’s an overview of the pros and cons of using equity to buy an investment property as well as some tips on how to use equity to buy a house.

Can you use equity as a deposit?

If you already own a home, you might be able to use the equity in your existing property to buy an investment property. But before you go digging into your equity to use as a deposit, you’ll need to work out how much equity you have on hand.

Start by working out the amount of equity you have in your existing property. Equity is the difference between the current market value of your property and the outstanding balance on your mortgage. For example, if your property is worth $800,000 and you owe $400,000, your equity is $400,000.

Next, you’ll need to figure out your usable equity. To use this equity as a deposit, you typically take out a home equity loan or line of credit. This involves borrowing against the equity in your home. Many lenders in Australia allow you to access up to 80% of your property's value, minus the outstanding mortgage. Based on the figures used in the previous example, you could potentially access $240,000 in equity ($800,000 * 0.80 - $400,000).

You can then put your usable equity towards a deposit for the investment property. For example, if the investment property costs $600,000 and the lender requires a 20% deposit, you would need $120,000, which you can cover using your equity.

The pros of using equity to buy property

Some of the key benefits of using your equity to buy an investment property include:

• No need for cash savings: You can leverage the equity in your existing property without needing to save up a large cash deposit. That way, you can take advantage of market opportunities more quickly than if you had to save for a deposit from scratch.
• Potential tax deductions: In some cases, you can claim the interest on a loan used to buy an investment property as a tax deduction. This can help to boost the overall return on your investment. You might also be able to claim depreciation on the investment property, further reducing your taxable income.
• Wealth building: By growing your property portfolio, you can potentially benefit from the appreciation of multiple properties over time, ultimately increasing your overall wealth. Rental income from the investment property can also provide a steady stream of passive income, but be sure to take your loan repayments and rental expenses into account too.
• Increased borrowing power: In some cases, using equity can allow you to borrow more than you could with just your income and savings, giving you access to higher-value properties.

The cons of using equity to buy a second home

Before using the equity in your property to buy a second home, it’s important to understand some of the drawbacks that come with this strategy.

• Increased debt: By borrowing against your equity, you’re essentially increasing your total debt, which can be risky if property values decline or if your income situation changes. Not to mention, the need to service a larger debt can put a strain on your finances, especially if interest rates rise or if rental income from the investment property isn’t as high as you anticipated.
• Market risk: The property market can be unpredictable. If the value of your rental property drops, it could affect the equity in your existing property, potentially leaving you in a negative equity situation where your debt outweighs the value of your properties. Borrowing too much against your equity can leave you over-leveraged, making it difficult to manage your debt and financial commitments. Economic downturns can also lead to decreased property values and rental demand, affecting both your home and investment properties.
• Financial strain: Managing multiple properties can lead to cash flow issues, especially if there are unexpected expenses such as repairs, vacancies or maintenance issues. Variable interest rates can rise, as we’ve seen recently, increasing your repayment amounts and potentially leading to financial stress if you haven’t accounted for a buffer.
• Tax implications: If you eventually sell the investment property at a profit, you may be liable for capital gains tax, which can reduce the net return on your investment. While interest on investment property loans is generally tax-deductible, changes in tax laws or limits on deductions could affect the financial benefits. Ultimately, the true benefit of tax deductions depends on your investment strategy and current financial situation.
• Complexity: The process of using equity as security to buy a second home is called cross-collateralisation. Managing multiple loans and properties can be complex and time-consuming. Plus, it often requires careful financial planning and monitoring, especially when it comes to cross-collateralised loans. The decisions you make for one loan could in turn affect the other mortgage, so it’s important to consider how you structure your home loans.

How to use equity to buy another property

So, you’ve weighed up the pros and cons of using equity to buy another house and you’ve decided this is the best path to property investment for you. Now what? Well, once you’ve figured out how much equity and useable equity you’ve got, you can start looking into different types of property that suit your budget, along with different financing options that meet your goals and align with your investment strategy.

For more information on turning your home equity into a property, check out our blog on how to use equity to buy your next investment property.

Whether you’re looking to refinance or take out a new home loan to buy an investment property, Unloan can help. Explore our different loan products today or check out our Learn hub for more information on buying an investment property.

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This article is intended to provide general information only. It does not have regard to the financial situation or needs of any reader and must not be relied upon as financial product advice. Please consider seeking independent taxation and financial advice before making any decision based on this information.

Tax law is complex and subject to change. For the latest information, check the ATO website or with your accountant or financial advisor.

Unloan is a division of Commonwealth Bank of Australia is also not a registered tax (financial) adviser under the Tax Agent Services Act 2009 and you should seek tax advice from a registered tax agent or a registered tax (financial) adviser if you intend to rely on this information to satisfy the liabilities or obligations or claim entitlements that arise, or could arise, under a taxation law.

Applications are subject to credit approval; satisfactory security and you must have a minimum 10% equity in the property. Minimum loan amount $10,000, maximum loan amount $10,000,000.

Unloan offers a 0.01% per annum discount on the Unloan Live-In rate or Unloan Invest rate upon settlement. On each anniversary of your loan’s settlement date (or the day prior to the anniversary of your loan’s settlement date if your loan settled on 29th February and it is a leap year) the margin discount will increase by a further 0.01% per annum up to a maximum discount of 0.30% per annum. Unloan may withdraw this discount at any time. The discount is applied for each loan you have with Unloan.

There are no fees from Unloan. However, there are some mandatory Government costs depending on your state when switching your home loan. For convenience, Unloan adds this amount to the loan balance on settlement.

* Other third-party fees may apply. Government charges may apply. Your other lender may charge an exit fee when refinancing.