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Loan Structure: when using equity in the main home to build your portfolio

This blog goes through step by step and show how to structure your portfolio when using equity in the main home to build the portfolio.

One of the most common starting points to building a portfolio is having large amounts of dormant equity in the family home. This is a great starting position to build a portfolio, as this equity can be used to grow a portfolio over time.
Here there are 5 steps to building your portfolio

Step 1: Release your Equity in a separate loan & set up a pre-approval for an investment purchase

Any investment purchase made will need a ‘deposit’ to be available to secure the property. If you plan on using equity as your deposit, the first step before making the purchase is to release the equity in your property and have the deposit funds made available.

Here, you calculate your equity and then release it in a separate loan account.

For example, John and Mary own their own home that has been valued at $500,000. They have a $100,000 loan. In this circumstance, using the equity calculator in the deposits chapter, John and Mary have $300,000 in equity available to you to utilise (pending meeting other eligibility criteria).

It makes sense to release this $300,000 into a separate loan account to your existing loan. This is because your existing $100,000 loan is for your own personal use (owner occupied) while the $300,000 will be used for investment purposes.

This $300,000 will be used to come up with the 20% deposits + costs for their future investment purchases. Now, in this example, the ‘equity’ release is quite large – $300,000. Depending on your investing strategy, this may indeed be used for multiple purchases.

John and Mary intend on purchasing cheaper investments assets valued around $350,000 – $400,000. Given another of the principles of loan structuring above is to have loans for specific purposes, they decide to ‘split’ this $300,000 loan upfront into 3 x $100,000 portion. Each $100,000 portion can be used to provide the deposits for 3 investment purchases.

Note, you will only pay interest on this $300,000 once used. Note, lenders will need to place the equity funds that they have released to you somewhere (into one of your accounts).

This can create a bit of a problem!

Usually lenders don’t leave the money ‘inside’ the loan account for you to draw on at your pleasure.  Only LOC facilities offer this functionality. Instead, they place the funds into one of your existing bank accounts, often not giving you much say about this!

It may be worth creating a separate offset account to have the funds sitting in temporarily while you are searching for the property.  For tax reasons, it is important to not put this $300,000 into your personal offset account.  It may make sense to have an offset against each loan split and leave the funds sitting there until used.  Alternatively, you can ‘pay back’ the $300,000 loan and have funds sitting inside the loans redraw account. This approach has its flaws with some lenders though, as they will automatically close the new equity account and assume you’ve paid it off!

While your obtaining your equity release, it may also make sense to do a pre-approval for the investment loan. This ensures that the bank are happy for you to make a purchase with the equity that has been released. This step is optional and may not be necessary, but may be worth doing if you plan on purchasing shortly after releasing the equity.

Step 2: Find a property to purchase that suits your investing strategy

Now that you’ve released the equity, you’re ready to go shopping and make offers! You use the equity funds that you have drawn out to pay this deposit.

The deposit is usually around 10% of the purchase price, with your remaining contribution and costs provided on settlement day.

Step 3: Finalise the Investment Property Loan

Once you have a signed contract, you then send the contract to the bank to finalise the investment property loan. This loan will likely either be for 80% of the value of the property, or for 88% of the value of the property (depending on your strategy/preference).

If you still have owner occupier debt, it may be best to have this loan as interest only repayments to begin with. This will allow you to allocate additional repayments to repaying your owner occupier mortgage first, and then later pay down the principle to investment debts. However, the additional price of interest only loans should be factored into this decision – it may not make sense if the cost of the interest only feature if too high.

The lender may do a valuation on the property and subject to the security you’ve purchased being acceptable, they will provide a ‘formal approval’ (unconditional approval). They’ve agreed to finance your investment property purchase!

You then send this document to your solicitors. From here, the bank will issue out a formal loan contract to you to sign and return. Depending on the bank, there may be a requirement for you to visit the branch and set up your accounts/identification here to.

Step 4: Settlement of the property

Usually settlement of a property happens between 28-42 days after the contracts are signed. This gives you time to obtain full finance approval and sign and return loan contracts.

On settlement day, you will need to make sure you provide the remaining portion of your deposit and other costs. It usually makes sense to set up a ‘direct debit’ authority with the lender, so that they can automatically debit one of your accounts on settlement day. Note, lenders can usually only debit accounts held directly with them.

An alternative approach is to transfer funds to your solicitor directly.

Step 5: Repeat Step 2-4!

Now that you’ve made your purchase, you can continue to do this with the remaining equity you have available. This will all of course depend on your borrowing capacity and meeting banks eligibility criteria.

John and Mary implement the 5 steps to this plan and now have 3 investment properties. This is how their loan structure looks:

Example – Loan Structure when using cash to invest

When you don’t have equity to begin with, you will likely need to come up with cash/savings to form the deposit portion.

In this situation, implement the same steps above. Of course, step 1 won’t be possible as there’s no equity available. Your existing cash reserves will form the deposit requirement for the purchase. We cover the financing specifics of this more specifically in the Deposits chapter.

Over time, equity should grow in the first property being purchased. This equity can come from either paying down the loan or by an increase in value. Once equity is available, implement step 1 and use this as the basis for any future purchases.


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