How to Use Equity to Buy Second Home

Purchasing a second property is becoming an increasingly popular option for many Australians. Whether it's for investment purposes or a holiday home, using the equity in your current home can be a powerful financial strategy. However, before you proceed, it’s important to understand how equity works and the steps involved in using it to buy a second home, especially within the context of the Australian property market and lending environment.

What is Home Equity?

Equity is essentially the difference between the current market value of your home and the amount you still owe on your mortgage. As you continue to pay off your loan and as your property increases in value, your equity grows. For example, if your home is valued at $1,000,000 and your remaining mortgage balance is $600,000, your equity would be $400,000.

You can use some of this equity to finance a second home, usually up to 80% LVR (read more here). The equity you've built over time can be accessed in various ways, allowing you to use it as a deposit or even to purchase the second property outright, depending on how much equity you have. However, it’s essential to remember that accessing equity means increasing your debt, so understanding the process thoroughly is key before making any decisions.

How Equity Can Be Used to Buy a Second Home

In Australia, there are several methods you can use to tap into your home equity. The most common options include refinancing your existing loan, taking out a line of credit, or using a home loan redraw facility if you’ve made extra repayments.

Refinancing allows you to replace your current mortgage with a new one, often increasing the loan amount to access the equity you've built up. This can be useful for purchasing a second home or making a large investment.

Alternatively, a line of credit loan lets you borrow against the equity in your home, providing flexible access to funds when needed.

With a redraw facility, any additional repayments you’ve made on your mortgage can be withdrawn and used towards your second home. Each of these options has its own advantages and drawbacks, so it’s important to weigh them carefully and seek financial advice tailored to your situation. If you want to speak to a mortgage broker about how to use your equity to buy a second home, fill out the contact form below.

Loan-to-Value Ratio (LVR) and Its Importance

Loan-to-Value Ratio (LVR) plays a significant role in how much equity you can use to buy a second home. LVR is the percentage of your property’s value that your lender is willing to finance. In Australia, most banks allow up to an 80% LVR without requiring lenders mortgage insurance (LMI). Continuing from the example above, if your home is valued at $1,000,000 and your remaining mortgage balance is $600,000, the most you can borrow is $800,000 (80% of $1 million). Since you still owe $600,000, you have $200,000 of usable equity.

Understanding LVR is crucial because it affects your borrowing capacity. The higher your equity and the lower your LVR, the more favourable your borrowing terms will be. Lenders assess LVR carefully, and a low LVR generally results in better interest rates and loan conditions. If you need to borrow more than 80% of the value of your property, you will need to pay LMI. There are a few exceptions, for example, some banks will waive LMI for borrowers from certain professions, including doctors, lawyers, nurses, teachers and veterinarians.

How Much Equity Do You Need?

To buy a second property, you generally need at least 20% equity in your current home. This is because Australian lenders typically require a 20% deposit when purchasing a second home, and your available equity can be used for this deposit. If your home is valued at $1,000,000 and your remaining mortgage is $600,000, you have $400,000 in equity. Depending on your lender's LVR policy, you may be able to use a portion of this to fund your second home purchase.

However, the amount of equity you need depends on various factors, including the price of the second property, your financial situation, and your lender’s terms. If you're buying an investment property, some lenders might require a higher deposit, while others might allow you to borrow a larger percentage of your equity. Understanding your financial position and having a clear idea of how much equity is required can help you avoid over-committing. Speaking to an experienced mortgage broker like EE Mortgages is a good idea, as they can help you work out how much equity you can use. They have access to over 40+ lenders, so they can find the best one for your situation, and they are able to negotiate the lowest interest rates. The best part is that they are 100% free of charge! Book a free call with one of EE Mortgages' brokers here.

Steps to Use Your Equity to Buy a Second Home in Australia

The first step in using your equity is to assess how much equity you currently have. You can do this by getting a property appraisal and subtracting your outstanding mortgage balance. Once you know how much equity you have, it’s time to speak with an experienced mortgage broker to determine how much you can borrow. A mortgage broker will calculate your borrowing power, which includes your income, expenses, and credit history, and help you secure approval for your loan.

Next, choose the best loan option for your needs. You could refinance your existing loan, opt for a line of credit, or use a redraw facility if you’ve made additional mortgage repayments. Once you’ve secured a loan, you can proceed with the purchase of the second home. Work closely with your mortgage broker to ensure you understand all the terms, and they can help you negotiate with the lenders for better rates or conditions.

Tax Implications and Considerations

Using equity to purchase a second home can have significant tax implications in Australia, particularly if the property is for investment purposes. For instance, negative gearing is a popular tax strategy where you can offset the costs of owning the investment property, such as mortgage interest, against your taxable income. This can reduce your overall tax liability while growing your property portfolio.

However, it’s also essential to consider the potential capital gains tax (CGT) liability if you sell the second property at a profit. Unlike your primary residence, which is exempt from CGT, investment properties are subject to this tax. It’s advisable to consult with a tax professional to fully understand the tax benefits and obligations associated with buying a second home using equity.

Risks and Benefits of Using Equity

The main benefit of using your equity to buy a second home is the opportunity to grow your wealth through property investment without needing to save a large deposit. Leveraging your existing home allows you to use your assets to generate more income or build your property portfolio. Additionally, with Australia's historically strong property market, many homeowners have seen their properties appreciate significantly, making equity an appealing option for financing.

However, there are risks associated with using equity. Borrowing more money means taking on more debt, which can strain your financial situation if not managed carefully. If the property market were to decline, you could end up with a lower property value and higher debt. It’s important to consider the potential for interest rate increases and ensure you can manage the additional repayments before deciding to use your equity.

Common Mistakes to Avoid When Using Equity

One common mistake when using equity is over-leveraging, which means borrowing too much and stretching yourself financially. It’s important to calculate your budget carefully and ensure you can afford the repayments, especially if interest rates rise. Keep in mind that while Australian property has generally appreciated over time, the market can fluctuate, and over-committing can lead to financial stress.

Another mistake is failing to plan for future changes, such as interest rate increases or changes in your financial situation. Ensure you have a buffer to cover unexpected costs or market downturns. Additionally, some homeowners focus solely on the potential benefits without considering the risks. Consulting a financial advisor or mortgage broker can help you navigate the process and make informed decisions.

Conclusion

Using your home equity to purchase a second property is a smart financial strategy for many Australians, offering the potential to grow wealth through real estate. However, it’s important to fully understand the process, assess your financial position, and seek professional advice before proceeding. By carefully considering the risks and benefits, you can make the most of your equity and expand your property portfolio confidently.

Seek Free Professional Advice

If you're considering using equity to buy a second home, it's essential to seek professional guidance to make informed decisions. Contact a mortgage broker today for personalised advice on calculating your available equity and exploring the best loan options to suit your financial situation. For more information, you can also check out our related articles, such as "Refinancing Home Loans in Australia" or "How to Negotiate Interest Rates with Banks," to help you better understand the process.