Refinancing your home loan can help you begin an investment journey.
Many Australians refinance in order to purchase an investment property to benefit from rental return and potential capital gain which can help borrowers repay their mortgage or use money to invest further.
To learn more about the benefits and risks of property investing, read our property investment guide.
While buying a property investment may be a good strategy, coming up with the funds for a deposit and associated holding costs can be difficult particularly if you already have a mortgage that you're paying off.
Refinancing is one way to help buy an investment property. It simply involves you refinancing your existing home loan and getting access to your equity to use as a deposit to purchase another property and diversify your portfolio.
Equity is the amount of your home you actually own. To determine the amount of equity that you have, take the property value and minus the amount that you owe on it to your lender.
Take a look at this example:
Brad wants access to his equity
Brad owns a home worth $500,000 and owes $200,000 left on it. This means he has $300,000 in equity and a Loan to Value Ratio (LVR) of 40%. After doing some research and speaking with his mortgage broker, Brad decides to buy an investment property. He refinances his existing mortgage with a new lender to get access the $200,000 of equity, which brings his LVR up to 80%.
Brad could've refinanced up to as much as a 90% LVR, giving him more to invest, but he decides not to as this would mean he'd have to pay a lender's mortgage insurance (LMI) premium.
With his $200,000, Brad buys an investment property and uses a combination of rental income and his salary to gradually pay it off.
If Brad built up more equity in both his home and investment property, you can see how Brad could carry this out again to purchase another investment property.
The risks of refinancing to invest in a property
Refinancing to borrow more and invest in an investment property can be a useful strategy for some borrowers, but make sure you evaluate the risks, such as:
- Depreciation. If the property falls in value, it may be difficult to build up further equity and you may be in a worse financial position. To minimise the risk of your property depreciating in value, make sure you carefully research the property market to buy in a location that is likely to provide capital gain over time.
- Market risk. If there is limited price growth in the area or there is not enough demand for property, then you may not receive a substantial rental income to cover your repayments. This is why it is essential that you conduct thorough research to ensure that there will be enough demand for your property type. Jump onto the council website to see what planned infrastructure developments are coming up and consider factors such as public amenities and days on market (DOM) to determine whether people are renting in the area.
- Difficult tenants. As an investor, you run the risk of having difficult tenants who may refuse to pay rent, or who may vacate the property without giving you sufficient notice. As a result, you may face untenanted periods where you need to use your savings to cover the repayments until you can find a new tenant. You can lessen this risk by using a property manager to help you attract high-quality tenants.
- Refinancing cost. Switching lenders and refinancing your mortgage can be an expensive process which is why you need to estimate the total refinancing costs involved. Sit down with an accountant and a mortgage broker to carefully consider the costs that you'll incur from exiting your current loan (e.g. discharge and government fees) as well as the costs of setting up a new home loan (e.g. application or establishment fees).
Use our calculator below to get an idea of your switching costs.
The risks associated with buying a property and the fact that your home is being used to fund it mean you should get professional advice and do your own research.
Decide the type of property you'd like to invest in- residential or commercial, apartment or house- as well as the areas you'd like to buy in.
Access suburb reports from sources such as RP Data and speak to as many professionals as you can to ensure that refinancing to invest in property is a sound financial strategy for you.