When to Use Equity vs Cash for Investment Property

Buying a second or third investment property requires a different funding approach than your first.

The question most McKinnon property owners face is whether to release equity from their existing home or save a cash deposit. That decision now depends on how lenders apply the debt-to-income cap introduced in February, how much rental income your next property will generate, and whether you intend to hold the asset beyond July next year when negative gearing restrictions take effect for certain properties.

How the Debt-to-Income Cap Affects Investor Borrowing

Lenders can approve no more than 20 per cent of new investor loans at a debt-to-income ratio of six times or greater. If your total borrowing across all properties, including the new loan, exceeds six times your gross income, your application sits in a restricted queue. Lenders manage that queue by reducing approved loan amounts, requiring larger deposits, or declining applications altogether when they approach the quarterly cap.

Consider a McKinnon household earning a combined income of $180,000 with an existing mortgage of $650,000. Adding a $600,000 investment loan would push total debt to $1.25 million, or 6.9 times income. That application would fall inside the 20 per cent cap and require lender discretion. Switching to a $500,000 loan by contributing a larger deposit brings the ratio to 6.4 times, still above the threshold but more likely to gain approval if the lender has capacity remaining in that quarter.

Using equity instead of cash does not change the debt-to-income calculation. Releasing $150,000 in equity and borrowing $450,000 produces the same total debt as saving $150,000 and borrowing the same amount. The ratio depends on total borrowing, not the source of your deposit.

Interest Only vs Principal and Interest for Investment Loans

An interest-only period reduces monthly repayments and preserves cash flow, which matters when rental income does not cover all holding costs. Most lenders offer interest-only terms of one to five years on investment loans, after which the loan reverts to principal and interest unless you apply to extend.

On a $500,000 loan at current variable rates, switching from principal and interest to interest only reduces monthly repayments by around $700 to $900, depending on the rate and term. That difference can absorb vacancy periods, body corporate increases, or higher land tax without forcing you to top up repayments from your salary.

Interest-only loans do not reduce the principal balance, so the total interest paid over the life of the loan will be higher. The structure works when you expect capital growth to exceed the additional interest cost, or when you plan to sell or refinance before the interest-only period ends. It does not suit investors who want to pay down debt or who are approaching retirement and need to reduce leverage.

When Negative Gearing Rules Change Your Deposit Strategy

From 1 July next year, rental losses from residential properties purchased after 7:30pm on 12 May this year can only be offset against other residential rental income or carried forward. You cannot deduct those losses against your salary or other income unless the property qualifies as an eligible new build.

That restriction does not prevent you from borrowing or claiming interest deductions. It quarantines the loss. If your investment property generates $28,000 in rental income and incurs $32,000 in deductible expenses including interest, the $4,000 loss can offset income from another investment property you own, or it can be carried forward to reduce tax when you sell or when the property becomes profitable.

If you do not own other residential rental property and do not expect the new property to generate positive cash flow within a few years, the quarantined loss provides no immediate tax benefit. In that scenario, borrowing less or choosing a principal and interest loan instead of interest only may reduce the annual shortfall, even though it increases monthly repayments. The alternative is to target properties where rental income covers most or all of the holding costs, which typically means accepting a lower purchase price or a different location.

McKinnon Property Owners Using Existing Equity

McKinnon sits within the Glen Eira local government area, where the median house value has risen consistently over the past decade. Many owners who purchased in McKinnon or nearby Ormond, Bentleigh, or Caulfield before the recent rate cycle now hold significant equity.

Releasing equity requires a valuation and, in most cases, an increase to your existing mortgage. Lenders assess your ability to service both the increased home loan and the new investment loan simultaneously, applying the three percentage point buffer to both. If your current lender cannot approve the additional borrowing due to debt-to-income constraints or policy limits, refinancing both loans to a different lender may provide access to the equity you need while securing a better rate on your existing debt.

Equity release does not require you to sell assets or disrupt your savings plan. It does increase your total debt and your exposure to interest rate movements on both loans. If variable rates rise by one percentage point, a household with $1 million in total debt will pay roughly $10,000 more per year in interest across both loans.

Fixed vs Variable Rates for Investment Property Finance

Fixed rates provide certainty over repayments for a set period, usually one to five years. Variable rates move with the market and allow unlimited extra repayments and access to offset accounts without penalty. Most lenders also allow you to split your loan between fixed and variable, allocating a portion to each.

Investors who expect rates to rise or who need predictable cash flow often fix part or all of the loan. Investors who want flexibility to make lump sum repayments from bonuses, tax refunds, or asset sales typically choose variable or split structures. The decision depends on your income stability, your plans for the property, and your view on rate movements over the next few years.

If you are purchasing an established dwelling under the new negative gearing rules, rental losses will be quarantined from July next year. Fixing the rate locks in your interest cost, which makes it simpler to calculate the annual shortfall and plan your cash flow. Variable rates give you the option to pay down the loan faster if your circumstances improve or if you decide to reduce leverage before the tax treatment changes.

Loan to Value Ratio and Lenders Mortgage Insurance

Lenders Mortgage Insurance applies when your loan exceeds 80 per cent of the property value. For investment loans, most lenders cap lending at 90 per cent, and some reduce that to 80 per cent depending on location, property type, or your borrowing history.

LMI premiums are calculated as a percentage of the loan amount and increase as the loan to value ratio rises. On a $600,000 loan at 85 per cent LVR, the premium may range from $12,000 to $18,000 depending on the lender and your profile. On a 90 per cent LVR loan of the same size, the premium can exceed $25,000. The premium is usually capitalised into the loan, which increases your total debt and your monthly repayments.

Contributing a larger deposit or releasing additional equity to bring the LVR below 80 per cent avoids LMI entirely. That approach requires more upfront capital but reduces your ongoing costs and simplifies the approval process. It also leaves you with a lower loan balance, which reduces interest charges over time and improves your serviceability for future borrowing.

Rental Income and Vacancy Assumptions in Serviceability

Lenders do not accept 100 per cent of projected rental income when calculating serviceability. Most apply a shading factor of 20 per cent, meaning they assess your ability to service the loan using only 80 per cent of the rent. If the property is expected to generate $600 per week in rent, the lender will credit $480 per week to your income.

That shading accounts for vacancy periods, maintenance costs, and the possibility that rent may fall or fail to keep pace with interest rate rises. It does not reflect the actual cash flow you will experience, but it determines how much you can borrow. Properties in areas with low vacancy rates and strong rental demand still attract the same shading, so the assessment is conservative across all locations.

If rental income is critical to your serviceability, choose a property where the rent is high relative to the purchase price. Regional areas and outer suburbs often deliver stronger rental yields than inner-city locations, though capital growth may be slower. McKinnon residents looking to invest locally should be aware that rental yields in the Glen Eira area typically sit below the metropolitan average due to higher property values, which means you may need a larger deposit or higher income to meet serviceability requirements.

Maximising Tax Deductions Within the New Framework

Interest on investment loans remains deductible regardless of when you purchase, provided the property is rented or genuinely available for rent. Other claimable expenses include property management fees, council rates, water charges, insurance, repairs, depreciation on fixtures and fittings, and body corporate fees where applicable.

From July next year, if those deductions exceed your rental income and the property does not qualify as an eligible new build, the loss is quarantined. You can still claim every deductible expense, but the net loss can only offset other residential rental income or be carried forward. Keeping detailed records of all expenses becomes more important under the new rules because those quarantined losses may be carried forward for several years before you can use them.

If you are purchasing an eligible new build, rental losses can still be offset against your salary and other income under existing negative gearing rules. The property must be constructed on previously vacant land or must increase the number of dwellings on the site. A knock-down rebuild that replaces one dwelling with one new dwelling does not qualify. If you plan to rely on negative gearing to improve after-tax cash flow, confirm the property's eligibility before exchanging contracts.

Call one of our team or book an appointment at a time that works for you to discuss your next investment purchase and how the debt-to-income cap, rental income shading, and the upcoming tax changes apply to your situation. We work with lenders across Australia to structure investment loan options that suit your income, your existing debt, and your plans for portfolio growth.

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