For many people, their first property is a stepping stone, and leveraging its value to invest further can open up new opportunities and help you achieve your long-term financial goals.

By using equity, you can accelerate your journey into property investment without needing to save up a huge deposit from scratch. It’s like giving yourself a head start in building your wealth, provided you know how to navigate the process effectively and are comfortable with the risks. The process might seem complex, but with the right knowledge and strategy, it’s entirely achievable.

In this Get Rich Slow Club episode, Ana and Tash are joined by Maddie Walton from Money Lounge to demystify the process. They walk through how equity works and discuss practical steps and risks to consider. Whether you’re new to property investment or just looking to expand your portfolio, this guide will give you a clearer path forward. Let’s get started.

Understanding equity

Before exploring how to use equity, let’s define it. Equity is the value of your property minus your remaining loan amount. For example, if your property is worth $1 million and your loan balance is $500,000, your equity is $500,000.

However, not all equity is usable. Banks will typically let you access up to 80% of your property’s value, keeping a 20% buffer as a safety net. This is known as “usable equity.” Using the previous example, you could access $800,000 (80% of $1 million) minus your $500,000 loan. That leaves $300,000 of usable equity to put toward a second property.

How does using equity work?

Maddie explains that a lot of people think equity is free money and that they can withdraw it without conditions. But equity is only accessible if you can service the additional loan required to tap into it.

Here’s how it works:

1. Revaluation of your property: To determine your equity, the bank needs to assess your property’s current value. A higher valuation means more equity.
2. Borrowing against your equity: Once you’ve identified usable equity, you’ll take out an additional loan (secured by your property) to fund the deposit and costs for your second property. This creates two loans: your existing home loan and the new equity loan.
3. Purchasing your second property: The equity loan acts as your deposit, while you secure a separate loan for the remaining purchase price of the second property.

Why use equity instead of cash?

Using equity can help you purchase a second property faster, especially as property prices rise.

“My property increased by $300,000 in three years,” Maddie explains. “I’m not saving $100,000 a year, so leveraging equity allows me to keep up with the market.”

Leveraging equity also enables you to build wealth using the bank’s money. As Ana points out, you’re using the bank’s funds to grow your portfolio, not just your own cash. This strategy can accelerate your wealth-building journey, provided you understand and manage the risks.

Risks of using equity

While using equity has its benefits, it’s not without risks. Here are key considerations:

1. Market fluctuations: If property values decline, your equity decreases. Maddie highlights: “In mining towns, for example, property values can halve if a mine closes. This leaves owners with a property worth less than their loan balance.”
2. Rising interest rates: Higher rates can reduce your borrowing capacity and increase your repayments. Maddie shares that she bought her property when interest rates were low, but as rates increased, her repayments went from $550 a week to $1,000.
3. Overleveraging: Taking on too much debt can strain your finances. Tash notes that being house-rich but cash-poor can be incredibly stressful, especially if your income changes or unexpected expenses arise.

Debt recycling: A powerful strategy

Debt recycling is a strategy that can make your equity work harder. This involves converting non-deductible debt (like your home loan) into tax-deductible debt by investing in income-generating assets such as investment properties or shares.

The process involves using surplus cash flow or investment income to pay down your owner-occupied loan, then redrawing the paid-down amount as an investment loan. Over time, the idea is to reduce “bad” debt and increase “good” debt .

For example, if you have $100,000 in your offset account, you could:

1. Pay down your home loan.
2. Redraw the $100,000 as an equity loan.
3. Use the equity loan to invest in shares or an investment property.
4. Use investment income (e.g., rent or dividends ) to pay down your home loan further.

Ana highlights that debt recycling creates a cycle where your investments generate income to reduce your non-deductible debt while increasing your wealth.

Practical steps to get started

If you’re ready to use equity to buy a second property, here’s how to begin:

1. Assess your equity: Speak to a broker to get a property valuation and determine your usable equity.
2. Calculate your borrowing capacity: Your broker will help assess whether you can service the additional loans.
3. Consult your A-team: Maddie emphasises the importance of working with professionals like your broker, accountant, and financial planner. They can guide you on the best strategy and help you avoid costly mistakes.
4. Plan for risks: Consider potential market downturns, rate hikes, and changes in your income. Think about putting a buffer in place to manage these challenges.
5. Make an informed decision: Whether you’re investing in property or shares , understand the long-term implications and align your strategy with your goals. If you're ever unsure of something, those aforementioned professionals can help you.

Final thoughts

Using equity to buy a second property can be a good way to grow your wealth, but it requires careful planning and a solid understanding of the risks. As Maddie says, your first property is crucial for setting you up, and you should take the time to think about your long-term goals and get the right advice to make informed decisions.

If you’re considering this strategy, start by building your A-team of professionals and educating yourself on the process. Remember, knowledge is power, especially when it comes to leveraging equity for future investments.

If this episode sparked something in you, give it a five-star rating, drop a review, or better yet, share it with a friend. And if you're just starting out, the first ten episodes will get the financial gears turning. Follow us at @getrichslowclub and catch our personal updates at @tashinvest or @anakresina.

Happy investing!