Guide to buying a rental property with a home equity loan

Your home's equity is the difference between its current market value and the remaining mortgage amount. Most banks will let you secure a new mortgage using the equity in your current property in place of a traditional deposit. In the process, lenders will also consider your ability to make repayments and your credit score. In Australia, you’ll need to own over 20 per cent of the house to be eligible for a home equity loan in most cases.

Buying a rental property with a home equity loan can be an effective investment strategy for some borrowers. You may be able to get a home equity loan within a few weeks of applying, and use this money to buy another property and then rent it out to help cover the repayments.

However, most lenders will want to be confident that you can still afford the repayments on this second loan using income from your job, as your investment property may not always generate reliable rental income. Your new investment property’s potential future rental income may not be a consideration in the lender’s assessment of your loan application.

Also, keep in mind that while you can also accumulate equity in your investment property over time, not every property is guaranteed to increase in value. This means you may not always be able to rely on being able to sell the property at a profit in the future, or be able to use this property’s equity to secure future finance.

If you already own an investment property, you may be able to apply for a home equity loan secured by this rental property. Much like when securing a loan with the equity in your owner-occupied home, you will be required to provide the financial institution with all the relevant details of your investment property when applying for a home equity loan.

Not all lenders will count all the rental income from an investment property when assessing whether you could afford the repayments on a home equity loan, as this income may not be considered reliable. Investors who appear too reliant on rental income may be at higher risk of being affected by rental downturns and the like, raising the risk that the borrower may default on their repayments.

One of the risks associated with buying property is that you have little or no control over its market value. If the property's value depreciates, you may be forced to sell it at a loss. On top of that, if you fail to get long-term tenants, you won’t be able to benefit from the support of extra rental income to help with your investment budget.

When buying rental property with a home equity loan, you offer the equity in your home as a deposit. If you cannot repay the loan for any reason, then the bank may proceed to repossess one or both of your properties.

Getting a home equity loan to buy a rental property is a significant financial move and entails certain risks. You should work out your future cash flows, understand all terms and conditions, and possibly consult an expert before opting for this route.