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Can you use your home equity loan to buy another house?

Jodie Humphries avatar
Jodie Humphries
- 5 min read
Can you use your home equity loan to buy another house?

Whether you want to purchase a second property for holidaying, investment purposes, or as a place for you (or your family members) to live in the future, a home equity loan may be a way to secure those keys. In this article we talk about what home equity is and how a home equity loan works.

What is home equity?

The equity in your home is the current value of your property, minus the remaining mortgage principal. Home equity is increased by making principal and interest mortgage repayments (including extra repayments) to help reduce the outstanding mortgage principal. Your home equity can also grow if the property values in your area grow.

Example

Let’s say you purchase a property for $700,000 by paying a 20 per cent deposit of $140,000 and taking out a $560,000 loan. This gives you $140,000 in equity to begin with.

After several years of diligently making your principal and interest repayments, as well as contributing some extra, you’ve paid back $140,000 of your $560,000 loan, reducing the remaining principal to $420,000.

At the same time, the value of properties in your area has increased, with a free property report telling you that your property may now be worth $800,000. 

The current value of your property ($800,000) minus the remaining mortgage principal ($420,000) means your current equity is $380,000.

How does a home equity loan work?

A home equity loan is where you use part of your available equity as security to borrow money, either as a lump sum to repay over time (like a home loan) or as a line of credit that allows you to borrow and repay money up to a pre-set limit, similar to a credit card.

How can I use a home equity loan to buy another house?

There are a few ways you can use the equity of your current home to buy a second property without a cash deposit. Let’s go through them.

Taking out a second home loan

The first option is taking out an additional mortgage for the new property

Most lenders will require you to keep at least 20 per cent of the equity in your property to reduce their financial risk, in the event you default on your repayments. You may be able to borrow a higher amount with some lenders, but you’ll need to pay Lender’s Mortgage Insurance (LMI), which will add to your costs. This means, if you don’t want to pay LMI, you’ll want a loan amount that is less than 80 per cent of the property value.

Line of credit loan

Line of credit loans let you access a set level of credit based on your home equity. You can use funds up to this set level and interest is only charged on the amount you use.

The maximum limit for a line of credit may be based on your available usable equity; however, some lenders may set caps on credit limits, even if you have more usable equity available.

Reverse mortgage

A reverse mortgage is a home equity loan that doesn’t require borrowers to make repayments while they still live in the home. Instead, the interest compounds over time, and borrowers only have to repay the balance in full when they either sell the property or pass away.

While reverse mortgages work like other home equity loans, they typically come with some additional rules and regulations. For example, you may need to completely own your home outright and be of pension age, as reverse mortgages tend to be geared towards older Australians who are ‘asset rich but cash poor’. 

It’s also important to understand that the income you access from a reverse mortgage could affect your pension, and have tax implications.

Cross-collateralisation

This option only applies if you plan on buying another property for investment purposes. 

Cross-collateralisation involves using your current property as collateral and adding it to a new investment home loan. This means you’ll have two home loans to repay - your original one and a new one that is secured by the existing property and the investment property. This can be considered a high-risk strategy because if you can’t service the debt on one of the loans, you could lose more than just that one property, so make sure to consider it carefully.

Things to consider before using a home equity loan to buy another house

Taking out a home equity loan on top of your current mortgage means you’ll have two home loans on the go, which is a financial decision you’ll want to seriously consider.

If you’re thinking about using a home equity loan to buy another house, you’ll need to make sure that the current equity in your home and your future income are adequate to ensure you’ll be able to pay both loans comfortably and on time. This is something that the lenders will also have to be convinced with, to give you the green light.

To make their assessment, lenders will look at your income, expenses and credit score to make sure you can afford the home equity loan, and are unlikely to end up in more debt than you can comfortably afford to pay back. There may also be other requirements, such as having adequate home insurance over the property.

Are there other ways you can use home equity without taking out another loan?

Yes, there are, by using the loan you already have. Discover the options below.

Refinancing

If you want to use your home equity to fund another property, but don’t want to take out a loan, you could consider refinancing your current mortgage. The idea is that you can increase the amount you’re borrowing, and then use that extra cash to put a deposit on a second house.

Redraw facility

If your mortgage has a redraw facility, you should be able to take out money (from any extra repayments you made) and put this towards a deposit on another property.

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Product database updated 16 Jun, 2024

This article was reviewed by Personal Finance Editor Alex Ritchie before it was published as part of RateCity's Fact Check process.