Building Equity: 4 Essential Moves to Secure Your Second Home/Investment Property

Building Equity: Many Australians struggle to purchase their first home due to the requirement of a substantial deposit. Even with sufficient income and borrowing capacity, the absence of a deposit can hinder the financing of a property. If you are reading this article, it’s likely that you have managed to secure a significant deposit for your first home or property and are interested in acquiring a second one. Once you own your first home, any equity you have accumulated can be utilized as a deposit for your next home or investment property, potentially allowing you to purchase your second property with minimal or no cash deposit, depending on your specific situation.

Your ability to refinance or obtain an additional loan, using your home as collateral, depends on your income, living expenses, and the outstanding amount on your mortgage. It’s important to be aware that borrowing more against your home’s value can lead to higher repayment amounts. This increase in financial commitment could elevate the risk of losing your home if you’re unable to keep up with the repayments.

In this article, we will explore how investors leverage the equity in their homes to purchase a second property and the reasons behind their decision to make such a purchase.

Building equity in your property

There are several strategies to actively increase the equity in your property beyond just making regular mortgage payments or waiting for the property market to appreciate in value.

1. Change your repayment habits

Equity is the difference between the value of your property and how much you owe to the bank, the less you owe on your home loan, the more equity you will likely have. If you are making mortgage repayments on a monthly basis, consider changing your repayments to fortnightly. When you make property mortgage repayments on a monthly basis, you typically complete twelve payments within a year. However, by adjusting your repayment schedule to a fortnightly basis, you effectively make a payment every two weeks. Given that there are 52 weeks in a year, this approach results in 26 half-payments, equating to 13 full monthly payments over the course of the year.

The principle behind this is simple: interest on property loans is typically calculated on a daily basis. Therefore, with each repayment you make, the outstanding balance of your property loan decreases, leading to lower accrued interest since it’s calculated on this reduced balance. By increasing the frequency of your repayments to fortnightly, you’re effectively lowering the loan balance more frequently, which in turn reduces the total interest charged over the term of the loan. 

2. Increase the value of your property Through Renovations and Improvements

Your equity is essentially tied to your home’s market value. Therefore, enhancing the value of your property can lead to a proportional increase in your equity. Strategic home improvements and renovations can significantly boost your property’s appeal and worth, thereby elevating your equity stake.

When considering renovations, there are a multitude of ways to augment the value of your property. Common upgrades that homeowners often undertake to enhance their living space and increase property value include:

• Painting: A fresh coat of paint can rejuvenate your home’s appearance, making it more attractive to potential buyers.
• Landscaping: Well-designed outdoor spaces can enhance curb appeal and create a positive first impression.
• Bathroom Renovation: Updating bathrooms can significantly improve the functionality and aesthetic of your home.
• Kitchen Renovation: The kitchen is often considered the heart of the home, and modernizing this space can greatly increase property value.
• Floor Replacement: New flooring can transform the look and feel of your home, making it more appealing to both the homeowner and potential buyers.
• Roof Replacement: A new roof not only improves the appearance and efficiency of your home but also adds to its safety and value.
• Additional Storage: Increasing storage space can make your home more practical and attractive, especially in areas where space is at a premium.

It’s crucial to assess these improvements within the context of your unique situation. If your goal is to build equity and potentially profit from your property, it’s essential to ensure that the cost of renovations does not surpass the value they add. Wise investment in renovations should aim at maximising return while minimising expense, ensuring that if you decide to sell, your enhancements contribute positively to your financial gain.

3. Linking an offset account.

An offset account is a financial tool that functions similarly to a savings account, with the key difference being its direct linkage to your home loan account. The primary purpose of this account is not to earn interest in the traditional sense, but to offset the interest charged on your mortgage. Here’s how it works: the balance you maintain in your offset account is used to reduce the principal amount on which your loan interest is calculated. For example, if you have a home loan balance of $300,000 and an offset account balance of $50,000, you will only be charged interest on $250,000 of your loan.

This mechanism can significantly accelerate the process of paying off your home loan. By effectively lowering the amount of interest you pay overtime, more of your repayment goes towards reducing the principal balance of your loan. This not only helps in paying off the loan faster but also in building equity in your property.

4. Making additional repayments

Making additional lump sum repayments on your mortgage can be a powerful strategy to boost your equity and reduce the total interest payable over the life of your loan. Once you’ve confirmed that your loan allows for additional lump sum repayments, any extra money you put towards your mortgage—whether it’s from a tax refund, a bonus, or savings—can make a significant difference. Not only do these extra payments reduce the interest cost, but they also expedite the journey towards owning your home outright. This approach not only helps in building equity faster but also provides a sense of financial security and freedom by reducing your debt burden. 

Can You Use All of Your Equity to Purchase a Second Property?

It’s important to understand that you usually can’t access all of the equity in your property. Most often, you’re allowed to access or borrow up to 80% of the property’s value before incurring additional expenses such as Lenders Mortgage Insurance (LMI)

For a clearer understanding, let’s consider an example: Suppose you own a property valued at $1 million, and you currently have a mortgage of $600,000 on it. This scenario calculates your equity as follows: $1 million (property value) – $600,000 (loan balance) = $400,000 in equity.

However, when considering usable equity, the calculation adjusts to accommodate the 80% limit, as shown below:

• Property value = $1,000,000
• 80% of property value = $800,000 (this is the maximum amount you could potentially leverage without incurring LMI)
• Loan value = $600,000
• Usable equity = $800,000 (80% of property value) – $600,000 (existing loan) = $200,000

Thus, in this example, despite having $400,000 in equity, the amount you can actually utilise for further borrowing, without triggering LMI costs, is $200,000.

Is Your Home Equity Loan Tax Deductible?

The tax deductibility of the interest on your home equity loan depends on how you use the funds. Generally, the interest on a home equity loan is tax-deductible if you use the equity to purchase an investment property that generates rental income.

Conversely, if you use the equity from your first home to purchase a second home for personal use, the interest on the home equity loan is not tax-deductible, even if you rent out your first home. The key factor is the purpose of the equity loan: it must be used to acquire a property that produces income for the interest to be deductible. 

Consider the following example where Bob and Jane are purchasing their second home. 

They secure a $400,000 equity loan against their existing property, valued at $1,000,000, to buy a new home. Instead of selling their first property, they decide to rent it out. The original home still carries a $250,000 mortgage, and the $400,000 represents an additional equity loan facility. This setup allows the two loans to be managed independently, yet both are secured by the same property.

In this arrangement, Bob and Jane can deduct the interest on the $250,000 loan associated with their first home, which is now a rental property. However, the interest on the $400,000 loan used to purchase their new home is not deductible, as this loan is not employed to generate income, despite being secured by their income-producing property.

In conclusion, leveraging the equity in your first home to secure a second property can be a strategic move towards expanding your investment portfolio and building long-term wealth. However, navigating the complexities of refinancing, understanding tax implications, and making informed decisions about renovations and repayments requires careful planning and expertise. At Investax, we specialize in guiding clients through the intricacies of property investment, ensuring that your journey towards securing a second home or investment property is both successful and stress-free. Whether you’re looking to maximize your equity, explore financing options, or simply seek advice on your next investment move, our team is here to assist you every step of the way.

Reference – 

ATO/Rental Properties – Interest Expenses 

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