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How to buy a second property with no deposit

Peter Terlato avatar
Peter Terlato
- 8 min read
How to buy a second property with no deposit

You’ve already bought a home and are paying off your mortgage, and now you’re thinking of getting a second home. Perhaps you’re considering buying this property as an investment, a weekender, or something you’d like to pass on to your kids.

Generally, in order to purchase another property you’ll need a deposit. The minimum deposit amount is typically in the range of 5-20% of the mortgage. You can put down more if you have available funds, thus reducing the size of your loan.

However, there are some alternative options you may want to explore if you don’t have funds for a deposit.

Using equity to finance a deposit

You could consider using the equity in your first home to borrow money for a deposit. Alternatively, you can refinance your existing mortgage for additional funds. You could also save money in your home loan offset account and use that as a deposit for the second property.

Equity is the difference between the current market value of your home and the outstanding  loan amount on your mortgage. For example, if your property’s current market value is $600,000 and the mortgage loan balance is $400,000, your equity is $200,000.

How does equity work when buying a second home?

You may be able to borrow against your home equity to buy a second home without cash for a deposit, however, you won’t be able to access all of the equity you have in your home.

Most lenders will require you to retain at least 20% of the equity in your property to help reduce their financial risk in case 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.

You can calculate your usable equity by subtracting your outstanding loan amount from 80% of your home’s current value.

Following from the previous example, if the property’s current market value is $600,000 and the mortgage loan balance is $400,000, then your usable equity will be $80,000.

To get a fair estimate of the amount you may be able to borrow, you could get a valuation of your current property. However, remember that even though it’s generally possible to increase your borrowing capacity to up to 80% of your property’s value, it’s not always the case.

The actual amount a lender may be willing to offer you will also depend on your personal circumstances. The lender will check your current financial situation to determine whether you’ll be able to repay the increased debt. They will check your income and expenses along with other outstanding loans, credit card payments, and other personal financial details.

There are two main ways in which you can access the equity in your home to fund the deposit for a second property.

How to buy a second property by refinancing

One option is to refinance your mortgage to increase the amount you are borrowing and then use the extra cash to purchase a second property. 

Increasing your home loan principal is going to increase the size of your monthly repayments, provided the term of the loan remains unchanged. If you think you cannot afford the increased repayments, you may opt to increase your mortgage term while refinancing.

However, you could end up paying a lot more in interest (even if you refinance to a lower interest rate) due to the increased number of months over which you’ll be paying off the loan.

How to buy a second property by taking out a second mortgage or home equity loan

The other way in which you can access your equity is by taking out a second mortgage or home equity loan. You may want to consider this option when your first mortgage is a fixed-rate loan and you are required to pay a high break fee for refinancing during the fixed period.

Alternatively, if your lender doesn’t approve a higher amount during refinancing, a home equity loan might be helpful. However, remember that you’ll have two loans on your existing property if you choose this option.

It’s also worth assessing your budget to determine the financial impact of purchasing a new property. When you use your equity to buy a second property, you’ll be taking out another loan to cover the purchase price of that property. It means you’ll be adding another mortgage on top of your existing home loan commitments, which could strain your budget. 

While the rental from a second property may help ease the burden to an extent, there may be periods when the property is vacant and you need to figure out how you are going to manage your repayments at such times.

If you are not sure about how much of your home equity you can use, or how it’s going to affect your repayments, you may want to speak with a financial advisor or mortgage broker who could crunch the numbers for you. This will help you determine whether using your equity to invest is a good choice for your situation or not.

Both refinancing and home equity loans let you borrow against the equity you have built up with your home. However, the most ideal choice for you will depend on your financial situation and personal goals.

Cross-collateralisation

Cross-collateralisation is a financial strategy used to leverage the equity in multiple properties. This approach allows homeowners and property investors to access additional funds for investment purposes.

The concept revolves around using the equity accrued in one or more properties as security for a single loan. By doing so, all the properties tied to the loan act as collateral, allowing for a higher borrowing capacity compared to applying for separate loans for each property. This may be beneficial for individuals looking to invest in additional properties without having to provide a substantial cash deposit.

One of the advantages of cross-collateralisation is the potential to minimise your loan-to-value ratio (LVR). The LVR represents the percentage of a property's value that is financed by the loan. By combining multiple properties as security, the total value of these properties can help reduce the LVR, leading to better loan terms and potentially lower interest rates.

However, cross-collateralisation also comes with inherent risks that should be carefully considered. Since all the properties are linked to the loan, any negative change in property values or a market downturn can impact all the properties used as security. Additionally, if you need to sell one property, it can be challenging to do so without affecting the entire loan arrangement.

Managing a cross-collateralised loan can be complex, as changes to the loan or property ownership may require extra paperwork and lender approval. Some lenders may also have limitations on redrawing or accessing equity individually for each property tied to the loan, which can affect the borrower's financial flexibility.

Given the complexities and potential risks involved, it is essential to consult with a qualified financial advisor or mortgage broker before considering cross-collateralisation as a strategy. They can assess your specific financial situation, discuss the potential risks involved, and provide guidance on whether this approach aligns with your long-term property investment goals.

Joint Ownership

Buying a second property with your spouse, a family member or even a friend may help you to share the cost burden of a deposit and other upfront and ongoing costs, such as stamp duty and building reports.

You may also be able to come to a personal arrangement where your co-owner covers the cost of the deposit if you aren’t able to contribute. You might then arrange terms to repay them by making higher repayments for a select period.

You’ll likely also be able to increase your borrowing power by combining all co-owners’ incomes and financial histories. And because multiple people share the burden of repaying the mortgage, you may be able to repay the loan faster.

Applying for a joint mortgage is, for the most part, a similar process to applying individually. You’ll need to provide all the relevant documentation and meet any necessary financial requirements.

Unsecured line of credit

There are various options available for accessing credit beyond the traditional personal loan with a fixed term. A line of credit may provide borrowers with a flexible and unrestricted way to obtain cash for a deposit.

With a line of credit, borrowers can avoid the constraints of set repayment timeframes and potentially costly interest charges. You'll only be charged interest on the actual amount of credit you access, rather than the full loan amount as in a standard personal loan. This cost-saving element can make a line of credit more financially economical in certain circumstances.

A line of credit may serve as a flexible credit option that provides borrowers with greater control over their finances. By accessing funds on an as-needed basis and charging interest solely on the amount used, it may be a practical choice for those seeking a deposit on a second property without the obligations of rigid loan terms and excessive interest charges.

However, it's important for borrowers to carefully evaluate their financial situation and objectives before choosing an unsecured line of credit. Consulting with a financial advisor could be beneficial in determining the most suitable credit solution for your needs.

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Product database updated 21 Jul, 2024

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

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