How Much Equity Do I Need to Buy an Investment Property?

Equity is a powerful financial tool that allows Australians to leverage the value of their existing property to purchase an investment property. It’s the difference between the market value of your home and the amount you owe on your mortgage, and it can act as a deposit for your next property. Understanding how equity works and how much you need, to buy an investment property is critical to making informed decisions and avoiding financial stress. By properly managing your equity, you can grow your property portfolio without relying solely on cash savings.

This article explains the role of equity in purchasing an investment property, including how much is typically required, how it is calculated, and the costs involved. It also explores the benefits, risks, and strategies to build and access equity effectively, helping you make the most of your property investment journey.

What Is Equity?

Equity represents the portion of your property that you own outright. It’s calculated by subtracting the outstanding balance of your home loan from the current market value of your property. For example, if your property is valued at $800,000 and you owe $500,000 on your mortgage, your total equity is $300,000. However, not all of this equity is available to use – only a portion, known as usable equity, can be leveraged for investment purposes.

Usable equity is typically determined by the lender’s loan-to-value ratio (LVR) requirements, which are commonly set at 80% of the property’s value. In the example above, an 80% LVR would allow you to borrow up to $640,000, meaning your usable equity is $140,000 ($640,000 - $500,000). Understanding usable equity is essential when planning to use it as a deposit for an investment property.

How Equity Can Be Used to Buy an Investment Property

Equity can act as a deposit for securing a loan on an investment property, eliminating the need to save a large amount of cash upfront. By leveraging the usable equity in your existing property, you can finance the purchase of another property while keeping your savings intact. This strategy is particularly beneficial for investors looking to grow their portfolios quickly or take advantage of opportunities in the property market.

To access equity, you’ll typically need to refinance your existing home loan with your lender or a new lender. This process involves reassessing your property’s value and your borrowing capacity. Once approved, the equity can be used to cover the deposit and associated costs of purchasing the investment property, such as stamp duty and legal fees. To assist you with working out how much equity you have and how to refinance your home, speak to an experienced refinancing mortgage broker from Eden Emerald Mortgages. Their services are completely free of charge, and they will make the process much easier.

How Much Equity Do You Need?

As a general rule, you’ll need at least 20% of the investment property’s value in usable equity to avoid paying lender’s mortgage insurance (LMI). For instance, if the investment property is worth $600,000, you’ll require $120,000 in usable equity for the deposit. Having sufficient equity not only saves you from additional costs like LMI but also provides a financial buffer for unexpected expenses.

In some cases, lenders may accept less than 20% equity, but this typically comes with higher costs and stricter lending criteria. Borrowing above 80% of the property’s value may also limit your options for favourable interest rates. Ensuring you have enough equity is essential for maintaining financial flexibility and reducing upfront expenses.

How to Calculate Usable Equity

Calculating usable equity involves determining your property’s current market value and applying the lender’s LVR requirements. Start by obtaining a professional valuation of your property to establish its current value. Multiply this value by the maximum LVR your lender allows (commonly 80%), then subtract the outstanding loan balance to find your usable equity.

For example, if your property is valued at $700,000 and your lender allows an 80% LVR, the maximum loan amount would be $560,000. If you owe $400,000 on your mortgage, your usable equity is $160,000. Understanding this calculation ensures you can accurately assess your borrowing power and plan your investment strategy. 

To help you work out your equity, it's a good idea to speak to a mortgage broker who specialises in refinancing. Contact Eden Emerald Mortgages to get in touch with an expert broker. They will work out how much you can borrow and assist you with refinancing your existing home loan. Their services are 100% free of charge and there is no obligation to use them after an initial phone call.

The Role of Loan-to-Value Ratio (LVR)

The loan-to-value ratio (LVR) is a key factor in determining how much equity you can use to purchase an investment property. LVR represents the percentage of the property’s value that the lender is willing to finance. For most investment property loans, lenders prefer an LVR of 80% or lower, ensuring the borrower has a financial buffer in place.

A lower LVR reduces the lender’s risk and may also result in better interest rates for the borrower. On the other hand, borrowing above 80% LVR may require LMI and can limit access to competitive loan products. Understanding how LVR impacts your borrowing capacity is crucial for structuring your investment effectively.

Costs to Consider When Using Equity

Using equity to buy an investment property involves more than just the deposit. Additional costs, such as stamp duty, legal fees, building inspections, and property management expenses, need to be factored into your budget. These costs can add up quickly, and failing to account for them can put unnecessary strain on your finances.

Budgeting for these expenses ensures you’re financially prepared for the entire purchase process. It’s also important to maintain a financial buffer to cover ongoing costs, such as loan repayments and property maintenance. Proper planning helps you avoid overextending yourself financially and ensures a smoother investment journey.

Benefits of Using Equity to Buy an Investment Property

Leveraging equity allows you to grow your property portfolio faster than saving for a traditional cash deposit. By using existing equity, you can take advantage of market opportunities and start earning rental income sooner. This strategy enables investors to build wealth and achieve financial goals more efficiently.

Additionally, using equity can be a cost-effective way to fund property purchases, as it eliminates the need to liquidate other investments or deplete savings. The ability to leverage an existing asset provides flexibility and opens doors to further investment opportunities. This approach is particularly beneficial for long-term wealth building.

Risks of Using Equity

While leveraging equity offers numerous benefits, it also comes with risks that need to be carefully managed. Overleveraging, or borrowing too much against your property, can leave you vulnerable to financial strain if property values drop or interest rates rise. This risk is particularly relevant in volatile markets or during economic downturns.

To mitigate these risks, it’s essential to maintain a financial buffer and ensure your repayments remain manageable even if circumstances change. Conducting thorough market research and seeking professional advice helps you make informed decisions and avoid overcommitting financially.

Tips for Building and Accessing Equity

Building equity faster can help you reach your investment goals sooner. Strategies such as making additional repayments, completing renovations, or waiting for natural property value growth can increase your equity. Monitoring the market and timing your refinance during periods of higher property valuations can also maximise your usable equity.

When accessing equity, consider refinancing with a lender that offers competitive interest rates and favourable terms. Working with a mortgage broker can help you compare options and negotiate the best deal. Taking proactive steps to build and access equity ensures you’re well-prepared for your next investment.

Seek Professional Advice

Consulting with professionals, such as mortgage brokers, financial advisors, and property specialists, is essential when planning to use equity for an investment property. These experts can provide personalised guidance on your borrowing capacity, equity calculations, and loan structuring. Their insights ensure your strategy aligns with your financial goals and risk tolerance.

Professional advice also helps you navigate complex processes like refinancing and understanding tax implications. By working with experts, you can make informed decisions and optimise your property investment journey. Seeking guidance is a critical step towards achieving long-term success.

Conclusion

Equity is a valuable resource for Australians looking to buy an investment property, but understanding how much you need and how to use it effectively is essential. Typically, having at least 20% of the investment property’s value in usable equity ensures you avoid additional costs like LMI and provides financial flexibility.

By calculating your usable equity, considering associated costs, and seeking professional advice, you can leverage your property assets responsibly to grow your investment portfolio. With careful planning and informed decision-making, equity can be a powerful tool for achieving your financial goals.

If you need assistance with finding the best properties to invest in, and tips on what to consider when buying an investment property, speak to a buyers agent from Eden Emerald Buyers Agent. A buyers agent can help you navigate the property market, finding you the right property to match your investment needs, access off-market listings, and negotiate the purchase price, saving you thousands of dollars. To get in touch, fill out the form below and a buyers agent will call you back.