Upsizing? How Equity Works When Buying a Second Home

Upsizing to a larger home can be an exciting time. What I often see from borrowers over my time mortgage broking is a trigger that has led to the search for a bigger home—a growing family, school choices or a need for more space.

These lifestyle needs, as well as recent increases in property values has brought forward many Australian homeowner intentions to upsize.

Perhaps one of the most common questions I have worked through with clients since 2008 is: How does equity work when buying a second home?

In particular, trying to solve the problem of financing the purchase of a second home while you still own your current home?

You have come to the right place! I have helped loads of borrowers who had equity in their current home property equity upsize to a bigger place. As with most things finance-related, no two scenarios were the same.

So, how does equity work when buying a second home? In this article, I’ll break down what property equity is, five ways it can help you upsize your home, and what to consider before using it.

What is equity in property?

Property equity is the difference between the market value of your property and any amount owed—like home loans.

A good example could be that if your house is worth $700,000 and you owe $300,000 – you have $400,000 in property equity.

If you have property equity and were to sell your property, after paying off any home loans, the remaining cash proceeds would represent your equity.

But what if you haven’t or don’t want to sell? There are loads of lending options that use property equity to buy a second home.

Wondering what your value is? Here are some free online property reporting tools to give you an idea of your property value.

How do you use property equity

Homeowners can use property equity to finance a second home purchase, provided lender eligibility criteria are met.

The staring point is to see a licensed mortgage broker. They are the professionals in this space and can walk you through everything I am about to explain.

Using our previous example where you owe $300,000. Say you bought the place years ago for $450,000. If the market value of the property increased to $700,000, your equity increased from $150,000 to $400,000.

You can explore with a mortgage broker the lending options available that use the increase in equity to help you buy a second home.

How does equity help when buying a second home?

When considering upsizing, most homeowners are also planning to sell their current home.

Instead of selling your home—or making an offer to purchase conditional to the sale of your home— it could help to understand how equity works when buying a second home.

Here are a the most common advantages I have seen in homeowners using equity when buying a second home.

Upsize without upheaval

Move once. Using equity when buying a second home means you can upsize without the upheaval. Moving home once is a big deal, so people like to avoid alternative buying options requiring you to move more than once.

No chain – No “subject to sale” clause

Using property equity when buying a second home allows you to limit the chain of events attached to a sales contract.

Conditions in any offer are normal. Each extra condition added to an offer to purchase invites some potential for the sale falling over.

Finance is a commonly accepted condition of an offer to purchase a property. Adding more properties to a transaction—like a ‘subject to property sale’ clause for your home— invites a layer of complexity and uncertainty. Something sellers are generally wary of.

Borrow the entire purchase price

The key to using equity work when buying a second home is that you can borrow to cover the entire purchase price.

When upsizing to a bigger home, the more variables you control, the more certain your outcome can be. This comes usually the responsibility of carrying a higher amount of debt.

The balance of risk and opportunity is a never far from a property conversation.

Build a property portfolio

Buying without selling is way I see borrowers become investors and begin their journey as a landlord.

The start of a portfolio of properties maybe? Using property equity to buy a second home, is not that different than buying a, third, fourth, and so on….

Of course, there are ownership and loan structure considerations that involve multiple properties which I write about here.

5 ways equity works when buying a second home

In my mortgage broking experience – I have helped borrowers use all these strategies to upsize.

Using equity to buy a second home usually involves an increase to your home loans—this can cost you interest.

• You borrow against your existing home to buy another one.
• Take on more debt.
• Hold two properties at the same time.

The illustration below shows how equity is used to buy a property for $1,000,000. The end loan includes current and new loans plus costs. That is how equity helps you upsize (guide only).

The reason to work closely with mortgage broker is to make sure you then split the home loan as needed so each loan matches the purpose of the funds. In each of the illustrations below I have detailed typical split home loans I have used.

1. Bridging loan

Bridging loans are a classic home loan solution that uses equity to buy a second home.

Initial queries I have had from borrowers about bridging loans centre around the mystery of the process and assumptions of it being expensive.

I demystified both the process and the cost of a bridging loan in my article.

Here is a nutshell summary:

• You have a property with a good amount of equity.
• You discuss with a mortgage broker or lender the possibility of buying a home on the condition that you will sell yours after the new purchase has finalised.
• You work through what your end loan amount will be after the eventual sale based on market valuation estimates.
• But because you have not sold your current home yet, here is where you also need a loan for the difference – enough to cover any existing loan plus the extra amount needed for the purchase. This is the bridging loan – the bridge that gets you across to the second property.

A bridging loan is a classic example of using equity when buying a second home.

Why would a lender agree to this? The lender puts a condition on the bridging loan that you pay it off (including interest costs) within, say 6-12mths with the sale of your current property.

Here is an example of how loans might be split for a bridging loan:

And there you have it – you used your equity to get the finance to upsize to a bigger home.

Once you sell your current home, there is your residual home loan to work on – but the rest is paid out.

Bridging loan – Pros and cons

2. Buy as investment

Using equity when buying an investment property is a popular strategy used by investors. The principle is to borrow everything for the investment property purchase – costs as well. Borrowers need to deonstrate they have the borrowing power to keep up repayments on both existing and new debt.

I have also seen this strategy used by borrowers wanting to upsize their house.

Essentially, they use equity to buy a bigger property and resist the urge to move in straight away. By using the property as an investment initially, they have rental income to assist with repayments and may also claim any tax incentives for investment properties. You could rent it out for a few years and then move in when it becomes for affordable to do so.

Upon moving in to the bigger house they may, or may not, sell their current home.

Buy as Investment – Pros and cons

Get professional tax advice if you are considering using equity to buy an investment property.

3. Convert current home to investment

Another strategy that uses equity to buy a second home involves converting your current property to an investment. Your ‘old house’ could now earn you rental income.

I see borrowers do this successfully when they seek advice early in their property journey. Establishing a loan structure that that factors in a future investment use for your current home is incredibly important.

Convert current home to investment – Pros and cons

Get professional tax advice if you are considering converting your existing home into an investment property.

4. Borrow everything – No rental income needed

Borrowing all funds on an owner-occupied basis is not available to all borrowers. It is for those with equity and income that qualifies them for a loan limit high enough to cover all costs.

I find borrowers in this position could have qualified for a bridging loan but preferred the idea of controlling the timing of when they sell.

Their priority is to secure the new purchase with finance and then decide on what to do with the current property later.

5. Access funds now – No rental income needed

Upsizing your home using equity usually requires both properties – existing and new – be used to secure new home loans.

But for those fortunate enough to have loads of equity and can meet eligibility for new lending.

I have helped borrowers get $1,000,000 in loans using there existing property equity so that they are ready to buy a property when it comes up. I have detailed how these borrowers access equity in the below illustration.

There are home loan structures available to ensure no interest is paid until you use the loan.

You are effectively shopping for property with accessible cash – once used it will attract interest like you would expect a home loan would.

Access funds now – Pros and cons

Alternatives to using equity to buy a second home

Property values have increased in recent years. But I have been involved in real estate finance for long enough to know it is not always the case. They can also decrease and stagnate – sometimes for years.

While many borrowers are in position to use equity to buy a second home, borrowers may also need to consider alternatives.

These alternatives involve selling your existing home at the same time, or before you upsize.

For many Australian borrowers it is the only option because they do not have enough equity. They need all equity available as cash so as not to be limited by loan to value ratio rules.

There are also a bunch of borrowers who err on the conservative side. They do not want to take on extra debt and be left holding both properties at the same time.

Sell your home first

This one initially makes sense on paper.

Step 1 – Sell
Sell your home > pay off your loan > cash in the bank.
Step 2 – Buy
Upsize to a bigger home > use your cash > get a new home loan.

But the issue of ‘where are we going to live in the meantime?’ usually leads these borrowers to a mortgage broker for advice.

I have seen borrowers do this with the following solutions:

• Rent back from new owner until they find a new place.
• Find a periodic rental with favourable ‘break lease’ terms while the search goes on.
• Move in with family.

Sell home first – Pros and Cons

Sell with a long settlement

Selling first with a long settlement period is a way of upsizing home without taking on the responsibility of extra debt.

Agreeing a selling price for your existing home can provide certainty around the amount of cash that will come your way when the sale is finalised.

The only catch? You limit the amount of time you have to find a property to upsize to. Given the bigger home purchase is sometimes referred to as a forever home, you may end up choosing the best of a bad bunch.

Worst case? You are back at option one – having to consider moving, renting and searching from there.

Long settlement – Pros and cons

Buy subject to sale

Buying subject to sale is a popular strategy for upsizing home in Australia.

This differs to a classic ‘finance condition’ as buying subject to sale means the sale cannot go through unless the buyer finds someone to purchase their current home.

Asking a seller to wait until you have found a property presents and obvious obstacle – but sometimes a seller is willing to accept this condition if they are happy with all other conditions. Especially the sale price.

These sale agreements should see the dates of the purchase of the upsized home and the sale of the current home align. Sounds tricky but I have seen it done countless times.

Subject to sale – Pros and Cons

Key investment considerations

Meeting with a licensed mortgage broker can make the confusing clear.

As with all things finance, I always recommend getting financial and tax advice when considering an investment angle to your upsizing strategy.

As much as there can be tax advantages to holding an investment property, there can be ongoing tax and capital gains implications for the investor.

Do you have enough equity to buy a second home?

This is why mortgage brokers do majority of home loans in Australia. I introduce borrowers to brokers so you can know what options are available to you.

Here are three steps to using equity to buy a second home:

Step 1: Assess Your Property Equity
Understand your market value using free property valuation tools to determine your home’s current value.

Step 2: Explore Financing Options
Are you open to taking control and using equity to upsize?
Or will be lean towards alternatives to using equity?
Consult with a mortgage broker to figure out a solution that is fit for you.

Step 3: Get Pre-Approved
A mortgage broker can take you through a pre-approval process to give you and a seller confidence.

Final word

Understanding how equity works when buying a second home is essential for homeowners looking to upsize.

Leveraging equity can make the upsizing process smoother but needs to be balanced by the responsibility of taking on higher debt levels.

Thinking about upsizing? I put Australian borrowers in front of licensed mortgage brokers to explore your home equity options.