Avoid These 4 Mistakes When Using Home Equity

Most PAYG professionals who own their home sit on more borrowing power than they realise.

If you bought five years ago and the market has risen, or if you have steadily reduced your mortgage balance, your property may now hold enough equity to fund a deposit on an investment property without needing to save for years. The concept is sound, but the structure matters. A poorly set-up loan can cost you thousands in unnecessary tax and interest, and the recent changes to negative gearing and capital gains tax add another layer of complexity.

What Equity Release Means for Property Investors

Equity is the difference between your home's current market value and the amount you owe on your mortgage. Lenders will typically allow you to borrow up to 80 per cent of your property's value without Lenders Mortgage Insurance (LMI), or up to 90 per cent if you are willing to pay the premium. That borrowing limit applies to the total loan amount secured by the property, not just the new funds you draw.

Consider a homeowner with a property valued at $900,000 and a remaining mortgage balance of $400,000. At 80 per cent LVR, total borrowing can reach $720,000. After repaying the existing $400,000, that leaves $320,000 in usable equity. A portion will be needed for stamp duty, legal costs and a buffer for holding costs, leaving the rest available as a deposit on the investment property.

Mistake One: Mixing Investment Debt With Private Debt

The ATO allows interest deductions only on borrowings used to produce assessable income. If you refinance your home loan and draw equity to buy an investment property, you must keep the new investment loan in a separate split or sub-account. Combining the balances into one loan makes it impossible to prove which portion of the interest relates to the investment property, and you lose the ability to claim that portion as a deduction.

In our experience, this is one of the most common structural errors, and it usually surfaces during the first tax return when the accountant asks for loan statements. By that time, the loan is already blended and the damage is done. Setting up separate splits at the outset takes a few extra minutes and saves years of compliance headaches.

Interest-Only Repayments and Cash Flow

Interest-only repayments allow you to hold the loan balance steady for a set period, typically one to five years, while minimising your monthly outgoings. This structure suits investors who want to preserve cash flow, claim the full interest deduction, and direct surplus income toward other investments or into an offset account linked to their owner-occupied loan.

An investment loan structured as interest-only at current variable rates on a $500,000 borrowing will carry a monthly repayment of around $2,100 to $2,300, depending on the lender and any rate discounts negotiated. Principal and interest repayments on the same balance would be closer to $3,000 per month. That difference can determine whether a property is cash flow neutral or requires ongoing top-up from other income.

Interest-only periods do eventually expire. At that point, the loan reverts to principal and interest unless you apply to extend the interest-only term. Most lenders will allow one or two extensions, but each request requires updated income verification and a fresh serviceability assessment.

How the New Negative Gearing Rules Change the Calculation

From 1 July 2027, rental losses on residential investment properties purchased after 7:30pm AEST on 12 May 2026 can no longer be offset against your salary or wages. Those losses are quarantined and can only be used to reduce other residential rental income, or carried forward to offset future rental income or capital gains on residential property.

Properties held before that announcement date are grandfathered and continue under the existing rules until sold. If you are using equity to buy an investment property now, the new property will be subject to the quarantined loss rules once they commence. That does not make the investment unviable, but it does mean the cash flow support you previously received through a lower tax bill will no longer be available. Instead of a partial rebate each financial year through your tax return, you will need to fund the shortfall from other sources or hold the carried-forward losses for use later.

This shift makes interest-only structures and properties with strong rental yields more attractive, because reducing the ongoing cash shortfall becomes a priority.

Borrowing Capacity and Serviceability With Multiple Loans

Lenders assess your ability to service the new investment loan by adding a buffer of 3 percentage points to the interest rate and calculating repayments on a principal and interest basis, even if you intend to take interest-only. They also apply a discount to the expected rental income, known as a shading factor, which is typically 80 per cent. If the property is expected to generate $600 per week in rent, the lender will use $480 per week in its assessment.

Debt-to-income caps introduced in February this year add another constraint. Lenders can fund no more than 20 per cent of new investor loans at a DTI of 6 times gross income or greater. A PAYG professional earning $150,000 can borrow up to $900,000 in total across all loans before hitting that threshold. If your owner-occupied mortgage already sits at $500,000, your maximum new investment loan would be $400,000 unless your income is higher or you are willing to accept a lower LVR.

These caps apply at the portfolio level, so refinancing existing debt to release equity can still trigger a DTI assessment if the total borrowing exceeds the threshold. Timing your application and understanding how each lender applies the cap can mean the difference between approval and decline.

Mistake Two: Underestimating Holding Costs and Vacancy Periods

Buying an investment property using equity means you are immediately servicing two loans. Even with rental income, there will be periods where the property is vacant, and you remain responsible for the full interest cost, body corporate fees, council rates, landlord insurance, and property management fees.

A typical vacancy rate in metropolitan markets sits between 2 and 4 per cent. In practical terms, a property rented at $600 per week might sit empty for two to three weeks per year. During that time, your cash flow shortfall widens and you need accessible funds to cover the gap. An offset account linked to your owner-occupied loan, or a buffer held in savings, provides that access without forcing you to redraw from the investment loan and blur the debt structure.

Capital Gains Tax and the 30 Per Cent Minimum Rate

From 1 July 2027, the 50 per cent CGT discount for individuals on investment properties purchased after 7:30pm AEST on 12 May 2026 is replaced with cost base indexation and a minimum 30 per cent tax rate on real gains. For properties purchased now, any gain that accrues before 1 July 2027 continues under the old rules. Gains accruing after that date fall under the new regime.

This change shifts the tax outcome for long-term investors, particularly those on lower marginal tax rates or those who intend to sell during a year when they are receiving a means-tested income support payment. The new minimum rate removes some of the flexibility that previously existed around timing a sale to minimise tax.

If your property investment strategy relies on capital growth as the primary return, the change to CGT treatment makes cash flow and holding period more important. Properties that deliver stronger rental yields and lower ongoing losses become more attractive, because the value is not entirely deferred to a distant sale date.

Mistake Three: Choosing the Wrong Property for Rental Yield

Not every property suits investment. A three-bedroom house in a sought-after school zone may deliver capital growth, but if the rental yield is below 3 per cent, the ongoing cash shortfall can be substantial. With quarantined losses from 2027, that shortfall will no longer reduce your tax bill in the year it occurs.

Rental yield is calculated as annual rent divided by purchase price. A property purchased for $800,000 that rents for $600 per week generates $31,200 per year, or a gross yield of 3.9 per cent. After deducting management fees, body corporate, rates, insurance and maintenance, the net yield might fall to 2.5 per cent. Meanwhile, your interest cost alone on a loan of $640,000 at 6.5 per cent is $41,600 per year.

Properties with higher rental yields, such as units closer to employment hubs or regional centres with strong tenant demand, reduce the size of the shortfall and make the investment more sustainable over the interest-only period and beyond.

Mistake Four: Failing to Separate Borrowings at Settlement

The final structural mistake happens at settlement. You arrange the finance, the lender approves the increased limit, and the funds are drawn to complete the purchase. But if the loan is not documented with separate splits at the time of drawdown, the investment funds are mixed with your private debt and the interest deduction is compromised.

This issue is entirely avoidable. A mortgage broker will ensure the loan is structured with distinct splits before settlement, so the paper trail remains clear from day one. The ATO does not accept retrospective separation of loan purposes, so getting it right at the outset is the only option.

When LMI Makes Sense for Investors

Borrowing above 80 per cent LVR triggers Lenders Mortgage Insurance, and the premium can add tens of thousands to your upfront costs. On an investment loan of $600,000 at 85 per cent LVR, LMI might cost $15,000 to $18,000, depending on the lender and the property type.

There are scenarios where paying LMI makes sense. If the alternative is waiting another two years to save a larger deposit, and property prices are rising at 6 per cent per year, the cost of delay may exceed the cost of the premium. LMI is also a one-time expense that can be added to the loan amount, whereas delaying the purchase means delaying rental income and the start of any capital growth.

The decision hinges on your cash flow, your confidence in the market, and your ability to service the higher loan amount. It is not a decision to make without running the numbers in detail.

Using your home's equity to purchase an investment property can accelerate portfolio growth and bring forward the timeline to financial independence. The new tax rules from mid-2027 change the cash flow equation, but they do not eliminate the underlying value of property investment for PAYG professionals with stable income and a medium to long-term outlook. Getting the loan structure right from the start, understanding how lenders assess your serviceability, and choosing a property with a sustainable rental yield are the factors that separate a successful investment from a costly mistake.

Call one of our team or book an appointment at a time that works for you.

Frequently Asked Questions