How to use home equity to buy an investment property
Whether you’ve paid off your home loan already, or are still chipping away at it, you may be able to use your home equity to buy an investment property.
In this guide, you’ll learn the typical process of buying an investment property using your equity, what home equity and ‘usable equity’ is, as well as how you may be able to increase yours for more borrowing power.
How does buying an investment property using home equity work?
Home equity can be used as security for a loan, or to help with your investment property deposit. That means you can borrow against the portion of your home that you’ve paid off, using what is known as ‘usable equity’.
This also means, however, that if you can’t pay off your investment property loans, your home and/or finances may be at risk. So, treat the decision to use home equity to purchase an investment property with caution and engage a financial advisor before going ahead with it.
But if you’re ready to go, or are curious about the process, here’s what you might do:
Steps to purchase an investment property with home equity
1. Get your current home valued
When applying for an investment loan using home equity, your lender will ask you for a recent property valuation of your home, or help organise one for you.
2. Calculate how much equity and usable equity you have to work with
Once you have your home valued, you’ll need to calculate your home equity (the value, minus the outstanding loan balance) and your usable equity (usually 80% of your home value, less the remainder of your home loan).
3. Increase your home equity if you need to
If you don’t have enough usable equity to secure a loan for an investment property, you can increase your equity by making improvements to your property, getting a more favourable property valuation, or making extra repayments to lower your loan-to-value ratio (LVR).
4. Compare investment home loans to find a competitive rate
Once you have enough home equity for the investment property you want to buy, you can compare investment home loans to find a competitive interest rate, taking care to read through investing guides and research home loan features.
5. Work out how much the property is likely to rent for
Now that you have an investment loan and property in your sights, make sure you use a mortgage repayment calculator to work out how much your monthly repayments will cost. That way, you can work out how much rent you will need to charge to cover your expenses (mortgage, real estate agent fees, etc.). You will also need to do some research into the local rental market to get a gauge on what renters are charged in the area.
Compare investment home loans
Plug in your loan amount and term to see your initial monthly repayment on a range of investment property loans in the Mozo database.
What is home equity?
Put simply, home equity is the market value of your home, minus the remaining balance of your loan.
For example, if your home is valued at $400,000 and still have $250,000 left to pay, your home equity is $150,000.
How to calculate your home equity
To calculate your home equity, use the following formula:
Home equity ($) = home value - loan value
However, when it comes to securing an investment home loan, you’ll need to work out how much of your home equity your lender will let you use. This is known as your ‘usable equity’.
What is usable equity?
Usable equity is the portion of your home equity that a lender will let you leverage to purchase an investment property.
Lenders calculate your usable equity as 80% of the value of your home, less the remainder of your home loan.
However, in a lot of cases, you can still secure a loan without a 20% deposit – you may just need to pay Lenders Mortgage Insurance (LMI).
How to calculate your usable equity
To calculate your usable equity, the formula is:
Usable equity ($) = (home value x 0.8) - loan value
Why? Well, if you used the full value of your home to buy an investment property, and the value of your home decreases, suddenly the asset you’re using as leverage isn’t worth what it once was.
It’s a way for your lender to create a safety net for their investment in you but also means you’ll have a 20% buffer in case the value of your asset drops – win-win.
While there’s a chance your home equity could decrease, you can also increase your home equity to help boost your borrowing power.
How do I increase my home equity?
As long as you’re continuing to pay off your mortgage, your home equity is, theoretically, increasing (provided your home isn’t decreasing in value).
Your equity can hinge heavily on the property market and economy, the supply and demand of property in your area, and any improvements made to your home (e.g. renovations, extensions, added features).
You can also opt to get multiple valuations from different valuers, as some might see more value in your home than others. Just be wary of costs blowing out, as valuations can cost anywhere between $200 to $600.
If you’re looking to boost your home equity, you could also consider making extra repayments on your current home loan to increase your ownership stake.
Of course, making extra repayments is less costly if your repayments are lower in the first place.
Mozo currently tracks 297 variable home loan rates, as of 13 December 2023. At the moment, the average variable interest rate in the Mozo database is 6.85% p.a., but we’ve found 191 lenders offering interest rates below that.
So consider refinancing, when possible, if you feel you’re paying too much with your current lender. The most obvious way to lower your repayments is to compare home loans and find a lower interest rate.
Compare investment property loans on Mozo - last updated 28 April 2024
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