How to Finance an Investment Property

23rd Aug, 2020 | Investor

In this article:
How do you fund an investment property, and can you use equity as a deposit on a second property?

Using the equity in your existing home is a common way Australians fund the purchase of their first, second or third investment properties. The advantage of using equity is that it can take the place of a deposit. If you have enough equity in your home, you might not need to pay a cash deposit.

Equity is the difference between what your home is worth and how much you owe on it. Over time your equity increases through a combination of a reduced loan balance and growth in your property value.

Useful reading: How Your Home Can Be Equity Rich

How much equity you have available will depend on a valuation of the property and your loan balance. If your home is worth $300,000 and you owe $100,000, you have $200,000 in equity. This is your actual equity. Your useable equity is slightly less because lenders want to ensure some of your equity remains as security. So, lenders will often use a loan to value ratio (LVR) of 80%, which reduces your usable equity to $160,000. A higher LVR will likely require Lenders Mortgage Insurance.

Tip!

When calculating the cost of funding an investment property, don’t forget about expenses like stamp duty, legal fees, building and pest inspections, accountant, insurance and a property manager. Your lender may give you the option to capitalise these costs into your loan amount.

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As part of your due diligence, you will want to conduct a market appraisal to work out your property value. When it comes to applying for a loan using your equity, your lender will organise an independent valuation.

If equity isn’t available, you’ll need to save for a deposit as you did for your first property. Alternatively, you may be able to draw down funds that you have stored in an offset or redraw on your existing mortgage.

Safer to stay with your existing lender?

A mortgage broker can position you to make the most of competitive deals on offer.

When funding an investment property, often investors stay with their existing lender because they think loyalty pays off or that it’s too difficult to switch lenders. The reality is that just because you have always banked with one lender, doesn’t mean this is where you will get the best deal. After all, your current lender might realise they don’t have to try too hard to win your business because there’s a good chance you’ll stay.

Your best approach is to speak to a mortgage broker who can position you to make the most of competitive deals on offer in the market. If this means moving to another lender to increase your mortgage or refinance, you might be pleasantly surprised at how seamless this process is. Your mortgage broker will guide you through the steps and help sort out the admin.

Two loans or one? 

With a process called cross-collateralisation, your properties can be used together to support your mortgage. Your first loan is increased to add another property as security, bringing both loans under a single mortgage.

There are pros and cons to cross-collateralisation, which are best discussed with your mortgage broker. A benefit is that it’s an excellent opportunity to ask your lender for a lower interest rate. A drawback is that because all properties are linked, a drop in the value of one property could significantly reduce the net effect of your total portfolio.

Interest-only loan? 

Some investors choose interest-only loans for their investment properties to take advantage of tax concessions. This type of loan reduces your monthly loan repayment as you only need to cover the interest. For properties with a good rental yield, you may find that the rent covers all your costs (known as positive gearing). Seek advice from a qualified accountant or financial adviser about whether an interest-only loan is right for you.

Useful reading: Principal and Interest vs Interest Only

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