Buying a Second Home in Australia Using Equity

Do you want to buy an investment property but don’t have the cash readily available for a deposit?

The good news is, if you already own a property, there is a way of buying a second home using equity instead.

Note: After all, property values are still far above pre-pandemic values, so it makes sense to take advantage of the equity boost in your home while you have it.

So if you're wondering how equity works when buying a second home, read on and find everything that second home buyers need to know.

How does equity work when buying a second home?

Equity in a property is the difference between the current market value of your property and how much you owe on it.

So, for example, if you own a property worth $1 million, with current home loan debt of $500,000, then you have $500,000 worth of equity.

But note, there is a difference between the equity in your home and what is deemed usable equity.

I’ll discuss this in more detail shortly.

The great news is that you can use the usable equity you have accumulated in your first property to help buy a second home - you would do this by using the equity as security for getting a deposit to buy your second property with a lender.

Essentially, that means that instead of saving another deposit, you can use the home loan payments you’ve already made to assist you with buying a second home.

Calculating usable equity

When you apply for your first home loan, a bank won’t lend you the full amount of the property value you’re trying to buy.

And buying a second home using equity is similar in that your lender won’t lend you the full value of your current property.

Instead, a lender will calculate what they call ‘usable equity’ which is typically equivalent to 80% of a property’s market value minus the remaining balance on your mortgage debt.

Here’s a calculation example:

Your home value is $1 million
80% of $1 million is $800,000
Your debt is $500,000, so subtract this from the 80% figure and you’re left with $300,000
This means you have $300,000 in usable equity.

Keep in mind that while equity gives you borrowing power and can be used as or towards a deposit, you’ll also need money to cover stamp duty and settlement costs so you might still need to make a cash contribution.

It is, however, possible to buy an investment property by borrowing more than 80% but you’ll incur the cost of Lenders’ Mortgage Insurance (LMI) which will be around an additional 2-3% of the loan amount, and your interest rate might be a little higher as a result.

The banks will also take your servicing capacity into account to determine how much you can afford to repay.

This is especially important in the current market when interest rates are high and likely to remain so for a while.

Calculating accessible equity

Accessible equity is another term to calculate the same thing - some lenders call it “usable equity” and some refer to it as “accessible equity.”

Either way, accessible equity is the equity that you can actually access on your property, which is lower than your total home equity - with 80% being the guide unless you pay LMI.

What are the options to access your home equity?

When it comes to working out how to access your home equity, there are 6 options to consider: refinancing, a line of credit, cross-collateralisation, a reverse mortgage, offset savings, or a redraw facility.

1. Refinancing

When you’re looking at buying a second home using equity, the first thing you’ll want to consider is refinancing your property.

Refinancing means you’ll be moving your home loan to a different home loan product, or even moving to another lender altogether.

It is one of the most simple ways to access your equity as the process of refinancing your mortgage will release your usable equity as a lump sum.

Tips: While this is the most common method many bankers will recommend, if your second property is going to be an investment property - definitely do not go down this route!

You see... Getting one be alone me that part of this loan will be for your home (which is non-tax deductible debt), and part of the loan will be for an investment which is a tax-deductible debt.

Mixing the two leads to an accounting nightmare

2. Line of credit

Another option is to apply for a line of credit, which means that you’ll be approved a certain credit amount based on your usable equity, but you’ll only start paying interest on whatever portion of that amount that you decide to spend.

The benefits of a line of credit include that it is a separate loan from your original home loan (see above) and that you’ll only pay interest on the amount used, unlike if you get a lump sum where you have to pay interest on the entire amount.

A potential disadvantage of this option is that a line of credit is effectively a huge credit card’ secured by your property, and just like regular credit cards, the temptation may be there to splash out on luxuries rather than investments, which could put you in hot water quickly.

3. Cross-collateralisation

Another option for buying a second home using equity is to take equity out of your property using cross-collateralisation.

This strategy involves using the equity from your existing property as security for loans on both properties.

So instead of releasing your equity to use as a deposit for buying a second property with a second loan, your loans will be linked and the equity in one property is used as collateral for both.

The danger is that if you are unable to make payment on the loan, the bank can repossess all properties under the loan.