Using your equity to buy a second home

When looking to access equity to buy a second property, loan providers can lend you finance against the value of your home, which puts property owners in a good position when looking to invest, retire or purchase a holiday house. If you have enough equity built up, you may be able to buy another property with no deposit at all.

Another strategy is to save money in a mortgage offset account and use that as a deposit. Using equity to buy a second home can help you purchase it faster. First, however, you need to make sure you have enough equity and understand how much you could end up paying in interest by borrowing against it.

How to use the equity in your home to buy another property

1. Assess your equity. How much money do you have at your disposal, and what can you afford?
2. Decide what type of property you’re buying. Buying a holiday home? Downsizing for retirement? Investing?
3. How to use equity to finance your purchase. Refinancing, take out a line of credit, get a bridging loan.
4. Get your mortgage application organised. Collect the paperwork, sort out your existing debts and take a look at your borrowing power.
5. Protect yourself. Cash flow and tax implications.

Equity explained

Equity is the difference between the current value of your property and the amount you owe on it. For example, if your home is worth $700,000 and you owe $500,000 on your mortgage, you have $200,000 equity.

How much equity is needed to buy a property?

First, you need to get an idea of your property’s value. How much could you sell your home for in the current market? Then, you can go onto a property listing website and look at recent property sales in your area. Be sure to look at similar properties (number of bedrooms and bathrooms, land size, location and so on).

• The equity calculation is simple: your property value minus your remaining mortgage debt = equity

Here’s an example:

• Property value = $750,000
• Remaining mortgage amount = $200,00
• Your equity = $550,000

Equity increases in two ways. First, you build equity by making your regular principal and interest repayments. The more you pay down the principal of your mortgage, the more equity you create.

The second way equity accrues is through your home rising in value. So, for example, if you paid $650,000 for your home and it’s currently valued at $700,000, you would have accrued $50,000 in equity through capital growth.

Here’s a more detailed example:

• You bought a property in 2015 for $600,000
• Your deposit was 20% or $120,000
• Now the property is valued at $720,000
• You’ve paid a further $90,000 off the mortgage principal by making repayments to the mortgage
• Your equity = $330,000

Lenders typically let you borrow up to 80% of the equity in your home to purchase a second property. So, in the example above, the amount of equity you can access is $264,000 (80% of $330,000).

Ways to finance your second home purchase

Working out your equity is one thing, but how do you access it? There are several ways, including refinancing your mortgage, taking out a line of credit or using savings from an offset account (or elsewhere) as a deposit and taking out a new mortgage.

Refinance

Refinancing your existing mortgage is a common way to unlock your equity when buying a second property.

Let’s use the example above, where you have $264,000 in equity to borrow against. You approach your current lender about refinancing to purchase a small unit as an investment. The unit costs $250,000.

You borrow against your equity to cover the purchase and use your savings to cover other costs.

Your lender agrees, and you apply for a new mortgage with them to cover your remaining loan and the new debt. You agree to a new mortgage term of 25 years.

• Note that altering your original mortgage and extending the loan term will likely result in you paying more interest throughout the loan. So while refinancing, it’s also worth considering if you get a lower interest rate and a better deal elsewhere.

Line of credit

Another way to unlock equity is through a home equity or line of credit loan, a separate loan that extends you an amount of credit based on the equity in your property. For example, if you have a significant amount of equity in your home, a line of credit loan could potentially account for most or all of your deposit.

A line of credit loan only requires you to pay the interest portion of the loan until you reach your credit limit. You can use as much or as little of the credit limit as you like and only pay interest on the amount you use, which can be a tax-effective strategy for investing in property. You maximise your tax-deductible debt by making interest-only repayments.

While a line of credit loan can help you invest in property sooner and carries significant tax advantages, there are some drawbacks. First, using a line of credit loan to invest in property could potentially see you managing three mortgages. Second, between your owner-occupier mortgage, the line of credit and an investment loan, using a line of credit for property investment can be cumbersome.

Another drawback of a line of credit loan is that you’re using your own home as security, which means that if you run into trouble repaying your line of credit when it’s due, your lender could seek recourse through your property. In the worst-case scenario, they could even foreclose on your home.

Offset savings

A borrower with money in their offset account has another option to fund their second property purchase.

Again let’s use the example above. Your home is now worth $720,000, your original deposit was $120,000, and you’ve paid off $90,000 by diligently making your monthly repayments. However, you’ve also been putting money into the offset account attached to your mortgage.

If you have put $1,000 a month in your offset over the last eight years, you’ve now saved $96,000, which can become the deposit on your new $400,000 investment property.

Now you need to take out a new investment mortgage to cover the remaining $304,000 and continue making repayments on your original mortgage.

Buying a new home and selling the old one

Not everyone buys a second home as an investment or buys a new home and keeps their existing property as one. However, some people want to upgrade byselling their current homesandpurchasing a new one.

However, it can be hard to get the timing right. You need to find a new property to buy, find a seller for your old home, and try to time the settlement days for each so you can have the money from the sale on hand to cover the new purchase.

If you’re in this second home-buying scenario, you have some options to make it easier:

• Be flexible on settlement dates.Try to be flexible withyour settlement dates. Check these in advance with the people you’re buying from and selling to. The longer the settlement window on your sale, the more room you have to move.
• Use offset savings.If you’ve made significant savings through your mortgage offset account, you can easily pull this cash out to form part or all of your deposit, which can let you buy a second house before you’ve sold the first. However, you might get stuck repaying two mortgages if you can’t sell your old home fast.
• Consider a bridging loan.Bridging loans are financial products designed specifically for people in this situation who are caught with a shortfall or gap between their sale and purchase settlement dates.

Make sure your finances are in order before buying a second home

Buying a second property is a serious decision. You may have plenty of equity to play with, but you don’t want to jeopardise the wealth you’ve built up by making a poor decision.

Here are a couple of steps you can take to protect yourself.

Cash flow

Whether you decide to refinance, top up your existing mortgage or take out a line of credit loan, you’ll make larger repayments, which requires careful budgeting to ensure you can service your loans. You need a healthy cash flow to pay back what you borrow.

If you’re investing, make sure you do your research to determine how much rental income you can generate versus the expense of managing the property and servicing your new debt.

Once this is determined, budget wisely to ensure you can comfortably manage any extra expenses. If your cash flow is positive, you’re in a good position. However, even if your cash flow is negative, you can benefit from negative gearing concessions at tax time.

Understand the tax implications

For tax purposes, your home is considered your principal place of residence. However, if you own a second property, you have to pay tax on the income if you rent it out.

With an investment property, you can deduct many property maintenance costs from your taxable income. However, you can only deduct expenses with a holiday home if you also rent out the property. Therefore, claiming deductions on a holiday home can be complicated if you use it yourself and rent it out at other times.

Need more help? Talk to a mortgage broker