Using Equity to Buy Property: How It Works

Home Equity Starts with Your Property Value and Existing Loan

Home equity is the difference between the current market value of your property and the amount still owing on your existing loan. As the loan balance falls or the property value increases, you may build equity over time. However, total equity and usable equity are not always the same thing. A lender generally will not allow all of the equity in your home to be borrowed. The amount that may be available depends on the lender’s assessment of the property, the loan amount, its lending policies and your financial circumstances. This means two borrowers with similar property values may have very different outcomes.

Usable Equity Depends on More Than the Market Value

When considering how much equity may be available, the lender will usually obtain or rely on a valuation of the existing home. The current market value you have in mind may be different from the value the lender uses for lending purposes. The difference between the lender’s property value and the existing mortgage balance helps determine how much equity exists, but only part of that amount may be useable equity. Whether there is enough equity to buy property will also depend on the purchase price of the new property, the size of the new loan and other costs connected with the purchase.

Using Equity Usually Means Taking on More Debt

Using equity to buy another property normally involves increasing the amount borrowed against the existing home, arranging a new loan, refinancing, or using a separate loan split. In practical terms, accessing home loan equity usually means taking on additional debt rather than simply withdrawing money already owned outright. That extra borrowing will affect loan repayments and may increase the amount of interest paid overtime. If interest rates rise, repayments on variable-rate lending may also increase. When considering using equity, some borrowers may review whether their household could continue to afford repayments alongside regular living expenses and other financial commitments.

Borrowing Power Remains a Key Part of the Lender Assessment

Home equity alone does not determine borrowing power. A lender will also review income, existing debts, credit limits, credit history, dependants, regular expenses and the proposed new loan. Rental income from an investment property may be considered, but lenders may not always use the full amount when assessing serviceability. This is why someone can have substantial equity in their home but still have limited capacity to borrow more. The lender is assessing whether the borrower appears able to manage the repayments, not only whether there is enough property value available as security.

Using Equity for an Investment Property Carries Additional Considerations

Using equity to buy an investment property can form part of a broader property investment approach, but it also increases exposure to debt. Loan repayments still need to be made if the investment property is vacant, rental income falls, interest rates rise or other household costs increase. There are also purchase and ownership costs to consider, including stamp duty, loan costs, property management expenses, insurance, maintenance and other costs. These expenses can affect the true benefit of using equity to invest and may place additional pressure on the household budget if they are not accounted for.

Some borrowers may also hear terms such as negative gearing, tax deduction, debt recycling or passive income when researching property investment. These areas involve tax, investment and financial planning considerations rather than finance broking alone. A finance broker can help explain how lenders may assess the loan, but tax implications are outside the broker’s role and can be discussed with a registered tax agent, accountant or tax adviser. Broader investment strategy questions may require professional advice from an appropriately qualified financial adviser or financial planner.

Loan Structure Can Affect How the Borrowing Is Managed

The way equity is accessed can matter just as much as the amount borrowed. Some borrowers may use a separate loan split for the funds connected with the new property, while others may refinance or arrange additional lending against the existing home. The available structure will depend on the lender, the purpose of the funds and the borrower’s personal circumstances.

Financial Stress Is an Important Risk to Consider

Using equity can increase the size of the household’s overall debt. That can create increased risk if income changes, interest rates rise, unexpected expenses occur or the new property does not perform as expected. Some borrowers may consider how much room remains in the household budget after allowing for loan repayments, living expenses and other ongoing costs. The risks involved will vary depending on the personal situation. The amount of equity used or retained in an existing home can vary depending on the borrower’s personal circumstances, borrowing needs, financial commitments and overall financial situation. There is no single general rule that suits every borrower, which is why the wider financial situation needs to be considered alongside the property value.

A Broker Can Help Compare the Lending Options

Eurobodalla Finance can help clients understand their home equity, existing loan and potential lending options before a property purchase, subject to lender assessment. Any new lending remains subject to lender assessment, and available lending options may depend on the borrower’s financial circumstances, property goals and ability to manage repayments. This article is general information only and does not take into account your objectives, financial situation or needs. It is not personal advice, credit, financial, tax, legal or investment advice.