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Property Equity & Home Loan Structuring
5 mins to read | 15 March 2023
How to unlock equity in your property and gain insights into home loan structuring
What is it about property, it’s Australia’s national hobby but many aspects of investing in the property market are confusing for borrowers to understand?
In this article we talk about how to unlock equity in your property and gain insights into home loan structuring.
What is equity?
Equity is simply the value of the property minus what you owe on your mortgage.
Useable equity is the additional money that you may be able to borrow secured by your existing property.
Borrowing more money sounds scary for many but when loans are used for investment purposes, there can be many upsides.
How can I calculate my useable equity?
Useable equity is worked out using the value of your current property multiplied by the maximum LVR ratio that lenders are willing to lend you based on your property type, typically this is between 70-80% less any current home loan you already have against that property.
Take an $800,000 house in your property portfolio, if you have an existing mortgage of $460,000, then you have $340,000 in equity. Assuming you can borrow up to 80% of your property value ($640,000), you may be able to access $180,000 ($640,000 - $460,000) of useable equity by topping up your existing loan.
If you plan to use it for investment purposes, it is often a good idea to split this amount into its own loan so that you keep your investment loan neatly separate to your owner occupied loan.
How does equity help me in my investment strategy?
Understanding how much equity you may have access to and how to structure your loans efficiently can help you get ahead in your investment property strategy, whether it is your first investment property or your third.
It is possible to use equity to borrow up to 100% of the purchase price of a new property plus enough extra to cover purchase costs for things like stamp duty and legal expenses.
Why would I want to borrow up over 100% of my investment property purchase price?
The reasons for borrowing over 100% of a new investment property purchase can be summarised by two major benefits - timing and tax benefits.
Timing
Firstly, if you wait until you save enough money for a 20% cash deposit on an investment property, you could be saving a long time before you have enough in the current market.
And if you save less than 20% deposit, you may have to pay Lenders Mortgage Insurance and that can be costly.
Tax benefits
Secondly, if you use your own savings as a deposit, you will not benefit from the tax benefits of deductible interest expense for that deposit, compared to when you use a loan product for the initial investment deposit.
Let’s use a worked example to illustrate:
Using savings to purchase an investment property
Owner LVR: 60%
Owner loan balance: $600,000
Owner Property value: $1,000,000
Savings: $150,000
Time taken to save $150,000 over and above existing loan repayments = 5 years, assuming savings of $30,000 for year which is $2,500 per month savings after all expenses. This is a lot and many people would need a lot longer to save this much.
New investment property value: $600,000
20% deposit and costs: $120,000
Stamp duty and other purchasing costs: estimated at 5% of $600,000 = $30,000
Total upfront cash needed for new purchase $150,000
New loan for 80% of the investment property purchase: $480,000
Owner loan: no change
Total tax deductible loans: $480,000
The cons with this approach are:
It takes someone 5 years or more to save enough for the initial deposit and upfront costs. By that time, property prices could have increased significantly.
By using savings to pay for upfront deposits and costs, you would not receive any tax benefits from the interest expense that you would get from an investment loan.
Using equity and a new investment loan to purchase an investment property
Using equity
Owner LVR: 60%
Owner loan balance: $600,000
Property value: $1,000,000
Savings: $50,000
New investment property value: $600,000
New loan for 20% deposit on $600,000 and costs secured against owner occupied equity (including 5% for costs: $150,000
New loan for 80% of the investment property purchase): $480,000
Total owner loan after top up: $750,000, split into $600,000 and $150,000 loans.
Total savings: $50,000
New loan for 80% of the investment property = $480,000
Total tax deductible loans: $630,000
Benefits:
At a Power Up Investor IO variable rate of 6.14% (7 June), this results in additional tax deductible interest of $9,210 per year on the $150,000 loan accessing equity that would not have been possible using your savings.
You also reduce your interest on the owner occupied loan by keeping money in your redraw or offset of $50,000.
And you can buy that investment property much faster by using equity instead of saving up for the 20% plus upfront purchase costs.
What does loan structuring mean and how does it work?
There are several things to think about when setting up your home loan for investment purposes and here is a quick checklist for you to consider.
Tax records
The most important thing is about keeping clear records for tax purposes.
The ATO has strict rules about what interest is deductible interest, so having split loans for investment purposes to keep things separate from your owner occupied loans is very important. Your accountant will also love you for it.
Purpose of funds
Related to tax records, is the purpose of funds. You should be careful to have your loan set up to reflect the actual purpose of the funds and make sure that you use the funds as intended. If not, you may encounter issues with the ATO if your accounts are ever audited.
For example, it is the use of funds that determines the loan purpose and interest rate, not the use of the security property.
Case study
I have an owner occupied property that I own outright and do not have any mortgage on it
I use the equity in my property to take out a new loan to invest in a new property
I also want to borrow some additional money to spend on renovations for my home
This is the correct structure for your loan:
A split loan, one for owner purposes for the renovation fund and an investor loan for the new property purchase.
Any surplus funds not used immediately should be kept in the respective loans offset account.
This is particularly important that investment funds are not used for personal purposes, otherwise your ability to claim a tax deduction may be impacted. You should seek professional tax advice on this.
Offset loans vs redraw loans
Why is it important to understand the use of offset loans for investment purposes? Because the ATO has a specific ruling about the treatment of tax deductible interest which is impacted by the use of redraw.
Whereas the use of Offset avoids any of these issues.
It is quite technical and boring but important – we are not the tax experts so you should speak to a tax professional for their advice. The short story is – offset loans if you need it, for both owner occupied and investment purposes are a good idea.
We also have multi-offsets that help you organise your money for different reasons easier.
Speak to the Investor Concierge team, our Aussie based loan experts, to find out how you can unlock the equity in your properties, book a call today.
You’ve got nothing to lose except your home loan!
Start saving a whole lotta time and money