Refinancing your home loan to buy an investment property

If you’ve been paying down your mortgage consistently while living in your property, you may be considering using your available equity to secure an investment property. 

While this strategy comes with its risks, there is also the potential of great reward through a successful investment. Before you start searching for investment opportunities, however, it’s worthwhile taking the time to ask yourself some tough questions.

Let’s explore what you need to know about purchasing an investment property through refinancing an existing home loan.

How to refinance to purchase an investment property

There are a few common ways that homeowners can refinance their mortgages to help with the purchase of an investment property. 

Refinance to access equity

If you’ve been paying off your home loan for some time, and if property prices have increased in your area, you’ve likely built up some equity. Some homeowners may consider refinancing to access this equity, which they may then use as the downpayment for an investment property. This is sometimes called ‘cash-out refinancing’. 

Instead of refinancing to, say, nab a lower interest rate, you will be accessing your home equity by refinancing your mortgage and increasing the loan size in the process. By increasing your loan size, you’ll be able to take out the extra money as cash and put it towards the new investment property. 

Look at the amount of useable equity you have in your current property and see if this will be able to serve as a deposit for the investment. You should ideally have 20% of the investment property’s value as a deposit. This size deposit means that you will avoid lender’s mortgage insurance and reduce the bank’s concerns about the potential risk of taking on more debt.

Keep in mind that by refinancing to access equity, you will be increasing your mortgage repayments, as your debt will be higher again. It is crucial that you check your budget to ensure you can afford the new higher loan repayments before you consider this option. 

Refinance to grow your savings 

Another way of refinancing to purchase an investment property could be to refinance your existing home loan to a lower interest rate to use the monthly savings to put towards paying off your investment property. This strategy will arguably take a lot longer, but it will help you avoid lessening your available equity and lowering your loan-to-value ratio (LVR). 

How to calculate useable equity

For the first strategy of cash-out refinancing, you’ll want to calculate your usable equity. Lenders will rarely, if ever, allow you to access all the equity in your home in case market prices drop and your loan ends up bigger than the value of the house.

Useable equity is around 80% of the value of your property minus any debt still owing. 

Calculating usable equity

Firstly, you’ll want to find your property’s value and your outstanding loan amount. Then you’ll multiply your property value by 0.8 and subtract your outstanding debt from that amount. Example:

• Your property value is = $880,000
• Your current outstanding debt is = $300,000
• $880,000 x 0.8 = $704,000
• $704,000 – $300,000 = $404,000
• Useable equity = $404,000

What to keep in mind about refinancing for an investment property 

Equity isn’t everything. You will also need to have sufficient income to service both home loans and still meet your everyday living expenses, which the bank will closely examine. 

If you have other credit in the form of personal loans, car loans and credit cards, this may reduce your borrowing capacity. It may be worth prioritising paying off existing debts before you refinance. 

Further, if you are still in the early stages of determining whether you can afford an investment property, you can use a mortgage calculator to estimate what your monthly repayments would be. Once you have an estimate of how much you’d need to borrow, and at what interest rate, you can mock up what your monthly repayment schedule will look like and see how that would fit into your current budget. 

It’s worth keeping in mind that every investment there comes with a level of risk, including higher vacancy rates, your property’s value growing more slowly than expected over time, or defaulting on your loan due to a lack of income. Your lender will try to assess this risk when you apply for an investment loan, which is why investment home loans often come with higher interest rates on average. 

How to find your new home loan options

While it can be easier to just refinance with your current lender to access equity or nab a lower interest rate, you could be leaving money on the table. 

If you have a sizeable deposit and a secure income, chances are that multiple lenders may be interested in your business. Plus, lenders typically offer lower interest rates to new customers. So, it is always worthwhile shopping around for competitive interest rates. 

Also, while refinancing your loan will typically come with initial costs and require your time in the research and application phase, it is expected that these costs will eventually be covered through the savings you gain through a lower-rate loan. 

Compare your options carefully so you can find the right investment loan for your budget and goals. Don’t just look at the interest rates, but also research factors like fees and features, so you can ensure you’re getting the best home loan for your financial situation.

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