What is equity?
Equity is essentially the value of your home, minus what you still owe on it.
For example, if your home is worth $800,000 and you still owe $500,000 on the mortgage, your equity in that property is $300,000. If you’ve paid your home off completely, your equity is simply what it’s currently worth on the property market.
But here’s the catch – there’s a difference between your total equity and your usable equity.
What is usable equity?
Most banks will let you borrow up to 80% of your property’s value. Some lenders may allow you to borrow more, but you’ll need to take out Lenders Mortgage Insurance (LMI).
Let’s look at an example:
- Your home is valued at $800,000
- 80% of that value is $640,000
- You still owe $500,000 on your mortgage
This means your usable equity is $140,000.
Using equity in your home to invest
Pulling equity out of your primary home to invest in another property is a strategy many Australians use to build their portfolios.
But investment doesn’t always mean buying another property. Many homeowners use equity to add value to their existing home through renovations. Whether it’s upgrading a kitchen, adding an extra bedroom, or creating more outdoor space. These improvements can boost both your home’s livability and its market value.
Equity can also be used on other big-ticket goals, such as funding that overseas holiday you’ve been meaning to take for a few years now, or the wedding you’ve been dreaming of since you were a kid.
The basic idea is that instead of saving a cash deposit, you can use the usable equity in your home as a deposit for your next purchase or as a way to invest back into your lifestyle and property.
How much equity do you need to buy an investment property?
There’s no one-size-fits-all answer, but there’s a useful guide known as the Rule of Four that you can use to determine whether you have enough equity to buy an investment property.
With the Rule of Four, all you do is multiply the equity you currently have available to you by four. So if we use the example above and you have $140,000 of usable equity available, multiplying that by four gives us $560,000 – which is roughly the amount you should be able to borrow in order to invest.
Keep in mind you’ll also need to factor in other costs such as:
-
Legal and conveyancing fees
-
Valuation fees
-
Land tax
-
Stamp duty (if applicable)
For example, if you find a property for $560,000 and the bank lends you 80% ($448,000), you’d use $112,000 of your equity as the deposit and set aside additional funds to cover the costs associated with the purchase.
Where does this leave my primary home?
If you want to pull equity out of your current home, you may need to refinance your existing home loan and get a specific investment loan.
As a result, your existing mortgage will likely increase, which means higher monthly mortgage repayments. So it’s not as simple as withdrawing equity – you’ll need to be confident you can manage the larger repayments on your home loan, as well as the repayments on your investment property (usually by renting it out).
It’s a good idea to speak to your local lender or financial planner first, so you can understand your options and find the structure that works best for you.
Should I use my equity to invest?
It’s a really personal decision to make. You should take your current financial circumstances and resources into consideration as there are risks to any investment. The bank will also closely assess your income, current debts, age, and other commitments before approving an investment loan.
While using equity is a popular way to build a property portfolio, there are risks to be aware of:
-
Interest rate changes can increase your repayments.
-
Rental vacancies may mean covering two mortgages out of pocket.
-
Market downturns could reduce property values and impact your equity position.
That’s why it’s important to seek advice from a financial planner before making any decisions.
Extra considerations
While property investment can be a great option for some, investors should be prepared to face different challenges with their property over time. This could include finding tenants to help cover repayments, or the possibility of property value decreasing if the market shifts, which could leave you having to pay two mortgages – the one on your investment property and the elevated mortgage on your primary dwelling.
Using equity to help build your property portfolio is possible, but speak with your local lender or financial planner before making any decisions to ensure it suits your financial situation. As always, we’re here to help. Speak to one of our expert lenders today.