Have you ever wondered how property owners use an asset they own to build a deposit for their next investment?
When you pay off your loan and your property value increases, the difference between those two amounts is known as equity.
In some circumstances, a lender may allow you to borrow funds against part of that equity to buy another property.
This is an equity release.
For property investors, it can be a useful way to fund a deposit and purchasing costs without having to save the entire amount in cash. But having equity does not automatically mean you can, or should, borrow against it.
Here is how using equity to buy an investment property works, what “usable equity” means, and the risks investors should understand before proceeding.
What is usable equity?
Usable equity is the portion of your property equity that you may be able to borrow against. The amount available will depend on the lender’s policies and your overall financial position.
Lenders will not always let you borrow against all the equity in your property. One of the key factors they consider is the loan-to-value ratio, or LVR.
LVR compares your loan balance with the value of your property. For example, if your property is worth $800,000 and you owe $400,000 on your home loan, your LVR is 50%.
A common way to estimate usable equity is to work out how much you could potentially borrow while keeping the total lending at or below 80% of the property’s value.
However, 80% is not a universal lending limit.
Different lenders have different requirements, and the amount you may be able to borrow will also depend on factors such as your income, expenses, existing debts and borrowing capacity.
Here is an example:
80% of $800,000 = $640,000
If the existing loan is $400,000:
$640,000 – $400,000 = $240,000 potential usable equity
In this example, the owner has $400,000 of total equity but approximately $240,000 of potential usable equity at an 80% LVR.
This is only an estimate. The lender’s valuation may be different from an owner’s estimate or a real estate agent’s appraisal, and the amount a lender is prepared to advance will also depend on its credit policy and assessment of the borrower.
How to use equity to buy an investment property
Using equity involves borrowing money, secured against a property you already own.
Suppose an investor owns a home worth $800,000 with a $400,000 mortgage. Following a lender valuation and finance assessment, they are approved to release $120,000 of equity.
That $120,000 could be used for the deposit and eligible purchasing costs for an investment property.
The investor would then generally have their existing home loan, additional lending secured against their existing property for the equity release, and a separate investment loan secured against the new investment property
The exact structure will depend on the lender and the investor’s circumstances.
The important point is that an equity release is additional debt. It gives an investor access to capital without having to sell their existing property, but the borrowed amount still needs to be repaid and will generally attract interest.
For an investor who wants to use equity to buy property in Adelaide, understanding this distinction early can make it easier to establish a realistic purchase budget rather than assuming the increase in their property’s value is automatically available as cash.
The advantages of using equity to buy investment property in Adelaide
Saving a cash deposit can take years. Investors with enough usable equity may be able to fund a deposit from an existing property instead.
That does not make the purchase cheaper, but it can change how the upfront contribution is funded.
An equity release may allow you to access some of the value built up in an existing property without selling it.
For investors who want to keep their current property while buying another, this can provide another funding option.
For an experienced Adelaide property investor, usable equity may form part of your investment strategy.
As property values, debt levels and household finances change, investors may regularly review their position to understand whether further investment is financially achievable.
Your loan structure can help separate borrowing that relates to different properties and purposes. This can be important for record keeping and future flexibility.
The ATO states that if borrowed funds are used partly for a private purpose, and partly to produce income, interest expenses may be divided.
For investors, this makes the purpose and movement of borrowed money an important consideration when setting up and using loan facilities.
Tax deductibility depends on how borrowed funds are used, not simply which property is offered as security. Investors should obtain tax advice about their own circumstances before relying on any expected tax treatment.
What are the disadvantages of using equity to purchase an investment property?
Using equity can create opportunities, but it also increases financial exposure.
Before proceeding, investors should understand what changes once they take on more debt.
Releasing $100,000 in equity means borrowing $100,000. It is not free capital created by a rise in property value.
Investors will generally need to pay interest on the borrowed funds, which means you need enough cash flow to service it, and the loan on the new investment property.
That becomes particularly important when interest rates rise or household income changes.
If equity from your home or another property is used to buy an investment, your existing property forms part of the overall lending position.
This means if you later experience serious financial difficulty and cannot meet your loan obligations, the consequences may extend beyond the investment property itself.
Understanding exactly which property secures which loan is important before signing loan documents.
Equity is not fixed.
If the value of your property decreases, the amount of equity you hold can fall even though your debt has not increased.
That may make future refinancing or further investment more difficult and is why using all your available equity can create less flexibility than maintaining a buffer.
Rent is not guaranteed income.
Vacancies, repairs, property management fees, rates, insurance and other things may arise.
Lenders also have their own methods for assessing rental income when calculating borrowing capacity and may not treat all expected rent as available income.
Therefore, investors need to consider how they will manage repayments if the property becomes vacant for a period or expenses are higher than anticipated.
This is one of the most important misconceptions investors make. You can have substantial equity and still not be able to obtain another loan.
Equity relates to the security available to the lender.
Borrowing capacity relates to whether the lender believes you can actually afford the debt.
To calculate your borrowing capacity, lenders consider factors such as income, living expenses, existing loans, credit card limits and other liabilities. They also assess proposed repayments under their lending requirements rather than simply looking at what you are paying today.
Should you release the maximum amount of equity available?
Not necessarily.
Maximum borrowing and appropriate borrowing are different things.
An investor may choose to release less than the amount technically available to have a buffer and keep repayments more manageable.
Before deciding how much equity to use, it can help to work through scenarios such as:
- What happens to your cash flow if interest rates increase?
- Could you cover repayments during an extended vacancy?
- What happens if the property needs a major repair shortly after purchase?
- How much cash will remain available after settlement?
- Are you planning another property purchase in the next few years?
- Would your position still be manageable if one household income temporarily reduced?
Questions to consider before using equity to buy an investment property in Adelaide
Before releasing equity for an investment property, get clear on both the opportunity and the downside. Start with the practical questions:
- How much equity is available based on a lender valuation?
- How much can you borrow once your full financial position is assessed?
- What will repayments look like after the additional lending is included?
Then look further at:
- How much cash you want to retain
- How you would handle a vacancy or unexpected repair
- Whether interest rate increases would be manageable
- How another loan may affect future borrowing capacity
Finally, make sure you understand the structure itself, by knowing:
- Which property secures each loan
- What each loan split is intended to fund
- Whether you need tax or financial advice before implementing the strategy
For an investor, getting those details clear before making an offer can prevent a property decision from creating an avoidable financing problem later.
Using equity is a finance decision, not just a property decision
A successful equity release depends on a suitable lender valuation, the amount of usable equity you have, your borrowing capacity, and a loan structure that makes sense your financial position.
It also needs to leave room for the realities of property ownership: changing interest rates, vacancies, maintenance costs, moving property values and unexpected expenses.
If you are considering using equity to buy an investment property in Adelaide, Rise High can help you discover how much equity may be available, assess your borrowing capacity, and compare investment lending structures before you make a purchase decision.
Speak with Rise High about your investment property finance options today.
Understanding what you can borrow is useful. Understanding how that borrowing fits into the bigger picture can help you make a more informed property decision.
