How to Use Home Equity to Buy an Investment Property in Australia

Introduction

For many Australian homeowners, the dream of building a property portfolio starts with the home they already live in. As property values have risen across much of the country—particularly in Sydney, Melbourne, and Brisbane—homeowners are sitting on significant equity that can be unlocked to purchase an investment property. This guide explains how to use home equity to buy an investment property in Australia, covering loan options, loan-to-value ratio (LVR) calculations, tax implications, and practical steps to get started.

Home equity is the difference between your property’s current market value and the outstanding balance on your mortgage. For example, if your home is worth $900,000 and you owe $400,000, your equity is $500,000. However, not all of this equity is usable; lenders typically allow you to borrow up to 80% of your home’s value, minus any existing debt, without incurring Lenders Mortgage Insurance (LMI). This usable equity can be used as a deposit for an investment property, potentially allowing you to enter the market without saving a cash deposit.

According to the Australian Bureau of Statistics, the total value of residential dwellings in Australia rose to $10.4 trillion in the December quarter of 2023, with the mean price of residential dwellings reaching $933,800. This growth has created substantial equity for many homeowners, making equity-based investment strategies increasingly popular. However, leveraging equity involves risks, and it’s essential to understand the mechanics, costs, and tax implications before proceeding.


Understanding Home Equity and Usable Equity

What is Home Equity?

Home equity is the portion of your property that you truly own. It increases as you pay down your mortgage or as your property value appreciates. For investment purposes, lenders focus on “usable equity,” which is the amount you can borrow against without exceeding a certain LVR threshold.

Calculating Usable Equity

To calculate usable equity, lenders typically use this formula:

Usable Equity = (Property Value x 80%) – Existing Mortgage Balance

For example:

• Current home value: $1,000,000
• 80% of value: $800,000
• Outstanding mortgage: $400,000
• Usable equity: $800,000 - $400,000 = $400,000

This $400,000 can be used as a deposit for an investment property. If you’re buying a $600,000 investment property, you’d typically need a 20% deposit ($120,000) to avoid LMI. Your usable equity covers this deposit, and you’d borrow the remaining $480,000 as a separate investment loan.

It’s important to note that some lenders may allow you to borrow up to 90% or even 95% of your home’s value, but this usually triggers LMI, which can add thousands to your costs. LMI protects the lender if you default, not you. To avoid LMI, sticking to an 80% LVR is advisable.

Factors Affecting Equity

• Property Market Movements: Equity can fluctuate with the market. A downturn can reduce your usable equity, while a boom can increase it.
• Mortgage Repayments: Principal and interest repayments reduce your loan balance, building equity over time.
• Renovations: Value-adding improvements can increase your home’s worth, boosting equity.


Loan Options for Using Equity

When using home equity to buy an investment property, you have several loan structuring options. Each has pros and cons regarding interest rates, tax deductibility, and flexibility.

1. Home Equity Loan (Line of Credit)

A home equity loan, often structured as a line of credit, allows you to borrow against your existing home’s equity up to a pre-approved limit. You only pay interest on the amount drawn. This can be used as a deposit for an investment property.

Pros:

• Flexibility: Draw funds as needed.
• Interest-only payments often available.
• Can be kept separate for tax purposes.

Cons:

• Interest rates may be higher than standard home loans.
• Temptation to overspend.
• Requires discipline to repay.

2. Cash-Out Refinance

This involves refinancing your existing home loan for a higher amount and taking the difference in cash. For example, if you owe $400,000 but refinance for $600,000, you receive $200,000 cash (minus costs). This cash can be used as a deposit.

Pros:

• Potentially lower interest rates than a separate equity loan.
• One loan account for simplicity.
• May access better loan features.

Cons:

• Increases your home loan debt.
• Mixing personal and investment debt can complicate tax deductions (see tax section).
• Refinancing costs (exit fees, application fees).

3. Cross-Collateralisation

Cross-collateralisation involves using your existing home as security for both your home loan and the new investment loan. The lender takes a mortgage over both properties.

Pros:

• May allow borrowing more than 80% without LMI in some cases.
• Can simplify the application process.

Cons:

• Both properties are at risk if you default on either loan.
• Less flexibility to sell one property without restructuring loans.
• Can limit future borrowing capacity.

Most financial advisors recommend avoiding cross-collateralisation because it ties your properties together, reducing flexibility and increasing risk. Instead, a standalone investment loan with a separate deposit from equity release is often preferred.

4. Standalone Investment Loan with Equity Release

The most common and recommended approach is to release equity from your home via a separate loan split or line of credit, then use that as a deposit for a standalone investment loan. This keeps the loans separate, making tax deductibility clear and preserving flexibility.

Steps:

1. Establish a new loan split on your home loan (e.g., a $120,000 equity release).
2. Use these funds as the deposit for the investment property.
3. Take out a separate investment loan for the remaining 80% of the purchase price.

This structure is often called “equity lend” or “deposit lend.” It’s widely used by Australian property investors.


LVR Calculations and Borrowing Capacity

Understanding LVR

Loan-to-Value Ratio (LVR) is the percentage of the property’s value that you’re borrowing. For example, a $400,000 loan on a $500,000 property is an 80% LVR. Lenders use LVR to assess risk, and a lower LVR often means better interest rates.

When using equity, LVR is calculated on both your home and the investment property. For your home, the equity release should not push your LVR beyond 80% to avoid LMI. For the investment property, an 80% LVR is also standard to avoid LMI.

Example LVR Calculation

Let’s say:

• Home value: $900,000
• Existing home loan: $400,000
• Desired equity release: $120,000

New home loan total: $520,000. Home LVR: $520,000 / $900,000 = 57.8% (well under 80%).

Investment property purchase price: $600,000

• Deposit from equity: $120,000 (20%)
• Investment loan: $480,000 (80% LVR)

Total borrowings: $520,000 (home) + $480,000 (investment) = $1,000,000. Total property value: $900,000 + $600,000 = $1,500,000. Overall LVR: 66.7%.

Borrowing Capacity

Lenders assess your ability to service both loans. They consider:

• Your income (employment, rental income from the new property)
• Existing debts and living expenses
• Interest rate buffers (usually 3% above current rates)
• Rental income is typically shaded to 75-80% to account for vacancies and costs.

A mortgage broker can help you calculate your borrowing capacity. Generally, to afford an investment property, you need a strong income and manageable existing debts.

Lenders Mortgage Insurance (LMI)

If you borrow more than 80% LVR on either property, you’ll likely pay LMI. LMI can cost thousands. For an investment property, some investors choose to pay LMI to enter the market sooner, betting that capital growth will outweigh the cost. However, this increases risk.

LMI Cost Example (approximate):

LVR	Loan Amount	LMI Estimate
85%	$510,000	$6,000 - $8,000
90%	$540,000	$12,000 - $15,000
95%	$570,000	$20,000+

These costs are capitalised into the loan or paid upfront.


Tax Implications of Using Equity for Investment

One of the biggest advantages of investing in property in Australia is the ability to claim tax deductions, particularly through negative gearing. However, the tax treatment depends on how you structure the loans.

Interest Deductibility

The Australian Taxation Office (ATO) allows you to deduct interest expenses on loans used for income-producing purposes. This means interest on the investment loan (the $480,000 in our example) is fully deductible. But what about the equity release?

If you borrow against your home to fund the deposit, the interest on that portion is also deductible if the funds are used for investment purposes. The key is the purpose of the borrowing, not the security. So, if you take out a separate loan split for the deposit and use it solely for the investment property, the interest is deductible.

However, if you simply redraw from your existing home loan (which may have been used for personal purposes), the ATO’s “mixed purpose” rules can make it difficult to apportion interest. That’s why a separate loan split or line of credit is recommended.

Negative Gearing

If your investment property’s expenses (including interest, rates, insurance, property management) exceed the rental income, you make a loss. This loss can be offset against your other income (e.g., salary), reducing your taxable income. This is known as negative gearing.

Example:

• Rental income: $25,000 p.a.
• Expenses (interest, etc.): $35,000 p.a.
• Net loss: $10,000
• If your marginal tax rate is 37%, you save $3,700 in tax.

Negative gearing is a strategy for high-income earners, but it relies on capital growth to generate overall returns.

Capital Gains Tax (CGT)

When you sell an investment property, you pay CGT on the profit. If you hold the property for more than 12 months, you may be eligible for a 50% CGT discount. There are also exemptions and concessions, so consult a tax professional.

Depreciation

You can claim depreciation on the investment property’s building structure (capital works) and plant and equipment (fixtures, fittings). This non-cash deduction can significantly improve cash flow. A quantity surveyor can prepare a tax depreciation schedule.

Record Keeping

Maintain clear records of all loan documents, interest statements, and expenses. The ATO requires evidence to support deductions. Using separate loan accounts for personal and investment debt is crucial.

Important: Tax laws are complex and subject to change. Always seek advice from a qualified accountant or tax advisor. The information here is general and not financial advice.


Steps to Buy an Investment Property Using Equity

Here’s a practical step-by-step guide:

Step 1: Assess Your Equity

Get a professional valuation or use recent comparable sales to estimate your home’s current market value. Subtract your outstanding mortgage to find your equity. Then calculate usable equity at 80% LVR.

Step 2: Check Your Borrowing Capacity

Speak to a mortgage broker or lender to determine how much you can borrow. They’ll assess your income, expenses, and the potential rental income from the investment property.

Step 3: Choose a Loan Structure

Decide on the best loan structure (standalone investment loan with equity release is often recommended). Consider fixed vs. variable rates, interest-only vs. principal and interest, and offset accounts.

Step 4: Get Pre-Approval

Obtain conditional approval for the equity release and the investment loan. This gives you a budget to shop for a property.

Step 5: Find the Right Property

Research areas with strong growth potential, rental demand, and infrastructure development. Consider engaging a buyer’s agent.

Step 6: Conduct Due Diligence

Organise building and pest inspections, review strata reports (if applicable), and get legal advice on the contract.

Step 7: Finalise Finance

Once you’ve found a property, your lender will conduct a valuation and finalise the loan approval. Your solicitor or conveyancer will handle the settlement.

Step 8: Settlement and Management

After settlement, you may need to manage the property yourself or hire a property manager. Ensure you have landlord insurance.


Risks and Considerations

Using equity to invest in property can amplify gains but also losses. Consider these risks:

• Market Downturn: If property values fall, you could end up in negative equity (owing more than the property is worth).
• Interest Rate Rises: Higher rates increase your repayments, potentially causing financial stress.
• Vacancy Periods: If your investment property is vacant, you still need to cover the mortgage.
• Over-Leveraging: Borrowing too much can strain your finances if your income changes.
• Tax Changes: Negative gearing and CGT rules could change, affecting your strategy.

Diversification is also important. Property is illiquid and concentrated; consider balancing with other assets like shares.

Benefits of Using Equity

Despite the risks, using equity offers significant advantages:

• No Cash Deposit Needed: You can invest without saving a large cash deposit.
• Potential for Capital Growth: Australian property has historically delivered strong long-term returns.
• Tax Benefits: Negative gearing and depreciation can reduce your tax bill.
• Portfolio Building: Equity can be recycled to buy more properties over time.

Case Study: Sarah and Tom’s Investment Journey

Sarah and Tom own a home in Melbourne valued at $950,000 with a $350,000 mortgage. Their usable equity is:

($950,000 x 80%) - $350,000 = $410,000

They decide to buy a $550,000 investment property in regional Victoria. They release $110,000 equity (20% deposit) and take a $440,000 investment loan. Their home loan increases to $460,000, but overall LVR is manageable.

Rental income is $450 per week ($23,400 p.a.). Interest costs on the investment loan at 6.5% are $28,600 p.a., plus other expenses of $5,000, totaling $33,600. The net loss is $10,200, which reduces their taxable income. They also claim $8,000 in depreciation, boosting their tax refund.

After five years, the property value rises to $700,000, and they’ve built more equity to consider another purchase.


Frequently Asked Questions (FAQ)

1. Can I use equity if I still have a large mortgage?

Yes, as long as you have sufficient equity (at least 20% of your home’s value after the equity release). Lenders will assess your overall LVR and borrowing capacity.

2. Is it better to use a line of credit or a loan split for the deposit?

A loan split is often cleaner for tax purposes because it creates a distinct loan for investment. A line of credit offers flexibility but may have higher rates. Consult a tax advisor.

3. What if my property value has dropped? Can I still use equity?

If your equity has decreased, you may not have enough usable equity to fund a deposit without LMI. You might need to wait for values to recover or save a cash deposit.

4. Do I have to pay tax on the equity I release?

No, releasing equity is not a taxable event because it’s a loan, not income. However, the interest may be deductible if used for investment.

5. Can I use equity to buy a property in a different state?

Yes, you can use equity from a property in one state to buy in another. Lenders will consider the location and rental market of the new property.

6. How does using equity affect my credit score?

Applying for new loans will trigger credit inquiries, which can temporarily lower your score. Managing loans responsibly will help maintain a good score.

Conclusion

Using home equity to buy an investment property is a powerful wealth-building strategy for Australian homeowners. By understanding usable equity, loan structures, LVR, and tax implications, you can make informed decisions that align with your financial goals. Always seek professional advice from mortgage brokers, accountants, and financial planners to tailor a strategy to your circumstances. With careful planning, equity can be the key to growing your property portfolio and securing your financial future.

References

• Australian Bureau of Statistics - Residential Property Price Indexes
• Australian Taxation Office - Rental Properties
• Australian Securities and Investments Commission - Home Loans
• Reserve Bank of Australia - Lenders Mortgage Insurance

Disclaimer: This article is for informational purposes only and does not constitute financial, legal, or tax advice. Consult a qualified professional before making any investment decisions.