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Have you ever wondered how investors buy a property without providing a cash deposit upfront? It’s most likely that they use the equity they have in one property as collateral to secure financing for another. When used correctly, equity is a powerful tool.

We recently discussed equity in episode 5 of our podcast, Your Lending Era. In today’s article, let’s revisit key moments from the podcast to better understand equity, and how using it could provide value to your property ownership and wealth creation goals.

So, what is “equity”?

Equity, simply put, is the difference between a property’s current value and its outstanding mortgage balance. For instance, a property valued at a million dollars with a $500,000 mortgage holds $500,000 in equity.

To determine the amount of equity in a home, a lender will usually conduct a bank valuation. This determines the market value of a property, which is one-half of the equation used to calculate available equity.

As David, our founder and director says in our podcast episode, “A bank will go into a property, conduct an inspection, and combine that with comparable market sales to determine what that property is worth.”

“Then they’ll minus the loan amount and tell you what your available equity is”.

Despite some homeowners’ optimism about their property’s value based on real estate appraisals, bank valuations, which often come in lower, are the standard.

This valuation forms the basis for calculating available equity, with banks typically allowing homeowners to borrow up to 80% of their property’s value without incurring lenders’ mortgage insurance (LMI). This cap is both a safety net against market fluctuations and a compliance measure for responsible lending.

How can you access equity?

Accessing equity can be done via ‘loan refinancing’ with either your existing lender or a new one. For purposes like upsizing a home while retaining the current property as an investment, refinancing might create two separate loans: one for the existing debt on an investment basis and another for the equity release, aimed at covering the down payment and associated costs of the new purchase.

This separation, often done for tax reasons, helps in maintaining clear financial records for tax deductibility purposes. Please note, this isn’t tax advice.

The process of extracting equity involves a loan application, requiring a lead time of four to six weeks to ensure funds are available when needed. These funds can then be allocated to an offset account or used directly, functioning similarly to a credit card limit that’s available for use at the homeowner’s discretion.

How do banks assess the amount you can borrow using equity?

When planning to purchase an investment property, banks conduct a comprehensive review of a homeowner’s financial situation. This includes potential rental income and associated costs of the new property, ensuring the homeowner can manage the financial responsibilities of both the existing and new properties.

David talks about the process in depth. “The bank is going to ask a lot of questions. What do we want the equity for? What are we going to use it for? What are we going to purchase? Do we need a pre-approval for that as well? How much is that property going to rent for? What are the likely outgoing expenses on that property? And they’ll bring that all together in their initial servicing calculator to work out, can we refinance the home, can we extract the equity and can we make a purchase?,” David says.

What is “cross-collateralisation”, and is it a good strategy?

Traditionally, homeowners might have opted for “cross-collateralisation” or “cross-securing” — linking two properties under one loan. This method, however, has fallen out of favor due to its inherent inflexibility and the complications it presents for future financial maneuvers.

David says, “It comes down to whether a full discharge or partial discharge comes down to property values in the future. So, it seems simple up front, but in the future it creates more complex calculations that need to be done. So let’s just make it simple,” David says.

This ‘split loan’ approach separates the loans based on their purposes—whether for refinancing existing debt, releasing equity, or financing a new purchase—thereby simplifying tax calculations and maintaining clear financial records.

However, despite the advantages of split loans, there are scenarios where cross-collateralisation might be unavoidable. In these cases, a meticulous plan, often spanning five to ten years, is devised to ensure a clear exit strategy.

As David explains, “If we are going to cross-secure, it’s really a case of, well, how do we get into this transaction? But we want to know how we’re going to get out of the transaction. What do we think future values are properties worth? What do we think future values of those loans are going to be paid down to? What’s our exit strategy? What do we think our bank is going to ask us to do or close or pay down in the future?”

“So there are certainly circumstances, time and other mitigating factors that you don’t have an option, particularly actually when there’s an unacceptable security.” Jess says.

David continues. “Correct. So sometimes you might cross two or three properties to provide enough equity to take one loan to go and purchase a security that is not acceptable to the lender,” David says.

While still using cross-collateralisation, this approach accounts for future property values, loan balances, and the financial institution’s requirements, highlighting the importance of strategic planning in property financing.

Do you need help unlocking the equity in your property?

If you’re looking for an expert team (and a broker with premium status) to help you identify and leverage the equity available to you, request a Free 30-Minute Finance Strategy Session during which you will…

• Get a better understanding of your equity status, and the lending options available to you
• Discover ways to save money on interest, fees, and charges that are specific to your unique situation
• Get an up-to-date picture of the lending landscape including rates, conditions, and how to structure loans
• Learn about our process to find you a loan that could save you thousands.

This no-obligation free session will be held with one of our experienced mortgage brokers. Please be assured this will not be a thinly disguised sales presentation. On the contrary, you’ll receive our best strategic advice, specific to your situation, so you too can accumulate multiple properties without sacrificing your current lifestyle and accelerate your progress towards wealth.

Schedule Your FREE 30-Minute Finance Strategy Session Today.

Learn more by watching our podcast

You can learn more about refinancing by taking a look at our “Using equity to grow your portfolio” podcast here or you can browse all episodes here.

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Please note, the numbers and assumptions listed in this article are for educational purposes only. Individuals should seek specific advice pertaining to their unique situation and the real estate market before making any decisions.

Trilogy Funding Two is a corporate credit representative (Representative Number 506131) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237)