Using home equity to buy your next property

Home equity is the difference between the market value of your current home and the amount you still owe on your home mortgage. If you’ve owned your home for a few years, there’s a good chance you’ve built up some reasonable equity, and this can be a valuable resource when it comes to property investment.

For example, if your home is worth $400,000 and you owe $250,000 on your mortgage, your available equity is $150,000.

It is important to remember that not ALL of this available equity can be used to purchase your next property. For example, if you are buying an investment property, and your lender allows you to access 80 percent of your home value ($320,000 in the above example) as security, then your useable equity is $70,000 which is the amount that you can use for your next property purchase in lieu of a cash deposit.

Would-be property investors need to remember that it is important to repay the mortgage on your home as fast as possible, because you do not receive any tax breaks on an owner-occupied mortgage. However, if you are in a tax bracket where your income is high and you have good cash flow, there is no reason not to use your useable home equity to buy an investment property - even while you are still paying off your home loan.

This is based on the principle that tax-deductibility of a loan is not determined by where the loan sits - rather, it is determined by what you use the loan for.

In the scenario above, even though you are borrowing money against your own home for the purchase of an investment property, the equity that you access ($70,000 in the above example) will be treated as a tax-deductible loan - since you have used these “new” borrowings for the purpose of purchasing an investment property.

Conversely, you may decide to purchase your next home to live in, and rent out your existing home. The additional equity that you access will not be tax-deductible since the new borrowings are for the purchase of an owner-occupied property. When you do move out to your next home and rent out your existing home, then the mortgage balance on your existing home ($250,000 in the above example) will be treated as a tax-deductible loan - since the “existing” borrowings are for the purpose of renting out an investment property.

In this second scenario, you need to consider taking a financial planner’s advice, since you are converting your existing home from a “capital-gains free” asset to a “capital-gains eligible” asset - which will be a key consideration when you decide to sell this existing home after a few years.

A third alternative can also be considered. It might be better for you to sell your existing home when you move out, take what is a capital gains tax free gain, roll all the money you realise into the new property you want to live in and then, if you still wish to invest, use the newly formed equity in that house to raise a debt to buy a rental property. This way the purpose for the new debt will be investment, and you will be allowed to legally claim the tax-deduction.

One final point - the property that you live in is not the only source of home equity. You can also use the equity in an existing investment property to help fund the purchase of another investment property.

Do not hesitate to call me on 0421 206 543 or email julie.browne@mortgagechoice.com.au for a confidential no-obligation discussion to work out how much equity you have in your property and how it can be accessed to fund your next property purchase.

Posted in: Property investment

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