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When to refinance and release equity

Refinancing to release equity - taking out a larger loan against an appreciated property, extracting the difference in cash - is the fuel behind most Australian property portfolios. Done well, it funds the deposit on the next purchase. Done badly, it creates a tax-inefficient and serviceability-stressed financial position.

The basic mechanics

  • Property bought 5 years ago for $700k with $140k deposit (20%) and $560k loan
  • Property now worth $900k after 5 years at 5% growth
  • Current loan balance (after 5 years of P&I amortisation): ~$490k
  • Current equity: $900k - $490k = $410k

If you refinance at 80% LVR on the new valuation:

  • New loan: $720k (80% of $900k)
  • Released equity: $720k - $490k = $230k in cash

What the released $230k can fund

  • Deposit on a second investment property up to ~$920k (at 25% deposit)
  • Major renovation on existing property
  • Other asset purchase (shares, managed fund, business)
  • Personal use (offset of other debts, lifestyle)

The tax rule that changes everything

Interest on the released equity is deductible only if the funds are used for income-producing purposes. This is the “purpose test” in Australian tax law.

If the $230k is used to deposit on an investment property, the interest on that $230k portion of the new loan is deductible against the rental income of the new property.

If the $230k is used for personal purposes (holiday, kitchen in your main residence, car), the interest is not deductible at all.

If the $230k is used partially for each (say $150k investment deposit, $80k kitchen renovation in your main residence), the loan interest must be apportioned - a messy accounting situation that can persist for the life of the loan.

The “contaminated loan” problem

Mixing deductible and non-deductible purposes in a single loan creates a contaminated loan. Every interest payment must be apportioned. If you later pay down principal, the payment must be apportioned across the two portions. This creates 20-30 years of compliance burden.

The solution: always use separate loan splits. Keep the original investment loan ($490k) separate from the equity release ($230k). If the equity release is used entirely for investment, interest on both splits is deductible. If part is personal, only that split has the apportionment issue.

Serviceability at the release point

Releasing equity increases your loan balance. The bank reassesses your serviceability at the new loan amount and current interest rates (plus APRA 3% buffer). Common traps:

  • Original loan approved in 2020 at 3.0% rates. Refinance in 2026 at 6.2%. Serviceability is much tighter.
  • Property now generating rental income at 4.0% yield; the lender discounts rental income by 20% for serviceability, so effective usable income is 3.2% yield.
  • The larger loan requires larger serviceable income.

Many investors who could borrow $700k in 2020 cannot borrow $900k+ in 2026 despite paying the original loan down. Serviceability is usually the binding constraint, not equity.

The strategic release sequence

1. Build genuine equity first. Don’t refinance early; let the property appreciate and the loan amortise.

2. Choose your moment. In rising markets, revaluations run 5-15% above purchase price after 3-4 years. In flat markets, it may take 5-7 years.

3. Consider which lender to release from. Your current lender may value the property conservatively; a new lender with a different valuer may produce a higher valuation.

4. Structure the new loan correctly. Split loans, clear purpose documentation, interest-only option for the investment leg.

5. Keep records of purpose. Save evidence of what the released equity funded. 5 years later, you’ll need it.

Release at 90% LVR

Some lenders will release to 90% LVR, with LMI applied to the portion above 80%. Example:

  • Current property value: $900k
  • Current loan balance: $490k
  • Release to 90% LVR: $810k new loan
  • Released equity: $320k (before LMI)
  • LMI cost: $10k-$18k added to loan
  • Net equity released: $300k-$310k

The LMI cost needs to be recovered via either the income stream or capital growth of the new asset. Worth it if the new investment yields 5%+ and grows at 4%+. Not worth it for marginal returns.

Don’t over-lever

The temptation is to release every dollar of equity and deploy. This is how property investor portfolios collapse in downturns. Keep at least:

  • 10-15% buffer LVR against current valuations (don’t go to 95% at portfolio level)
  • 3-6 months of interest payments in cash across the portfolio
  • An emergency income contingency if your employment or main business changed

Equity release is a tool, not a strategy. The strategy is the asset selection and the portfolio structure. The tool funds it.