Using Home Equity for Investment: Pros and Cons

Using the equity in an existing home to fund an investment is a popular route many homeowners take.

Leveraging home equity for investments is a great way to diversify income and build your overall wealth, among other benefits (but we’ll get into that later). Where there are pros to every financial investment, there are potential cons too - and using home equity for investment is no exception.

How does using home equity for investment work?  

Equity is the difference between the market value of the property and the amount still owed on a home loan.

For example, if a property is worth $700,000 and $400,000 is owed on the home loan, equity is $300,000. However, not all equity is accessible for borrowing; you’ll need to calculate the usable equity.

Your home’s equity is the gap between its market value and what is left on your mortgage. Lenders generally allow for access up to 80% of that amount, which is the usable equity. Based on the previous example, usable equity would be $160,000 (80% of $700,000 ($560,000) minus $400,000). Usable equity can be used as a deposit for an investment property.

Pros of using home equity for investment

• Access to funds: When an investment opportunity arises, you don’t want it to pass because you haven’t saved for a deposit. That’s where using home equity comes into play. It provides funds quickly without having to save the money or sell your current property.
• Tax deductions: Using equity for an investment can make the interest tax-deductible, improving overall return on investment.
• Lower interest rates: Home loan interest rates are generally lower when borrowing against home equity.
• Increase borrowing power: Equity can be used instead of a cash deposit, which, in turn, increases borrowing power. Borrowing power is calculated on factors like income, current loans, credit history, number of dependents, and available equity. The more equity in an existing property, the higher the security is on a new loan - making the investment less of a risk for lenders.

Cons of using home equity for investment  

• Increased payments: Owning investment properties comes with expected costs, like home loan repayments, but it also comes with unexpected costs, like repairs, vacancy, and interest rate volatility. This makes the management of cash flow crucial both short and long term.
• Higher financial risk: An unpredictable property market can lead to fluctuations in property value, the economy, and interest rates - making property investments a high financial risk. This can reduce a property’s equity and, in some cases, lead to negative equity (when total debt outweighs a property’s value).
• Cross-collateralisation: While not necessarily a negative, cross-collateralisation is something to be aware of when using home equity for investment. Cross-collateralisation means a property, from which equity is drawn, becomes additional security for a new loan. From there on out, every decision made on one loan or property will impact the other.

Using home equity for investment can offer a range of benefits - if done right. Before accessing your home equity to invest, you must consider all costs associated with the loan, your current and projected cash flow, and potential risks. Seeking professional advice will help clarify the pros and cons of using home equity for investment.

At Before U Loan, we understand the ins and outs of borrowing and work with Australians to find the best finance option for their situation. We can connect you with a network of approved loan brokers across Australia who will answer all your questions about using home equity for investing. Explore our list of loan brokers today.