How to Use a Property's Equity to Purchase Another Investment
In many ways, investing in real estate can be high risk, high reward. The high of chasing a new investment, whether that means outfitting a rental property or preparing to put a fix and flip back on the market, can be intense, especially in a volatile market.
For those new to the process, it can seem like the only way to grow a portfolio is to have a large amount of excess cash on hand or that it's necessary to sell a property in order to acquire funding for future purchases. However, this isn't necessarily true. It's possible to use the equity in a property to purchase another investment, giving you, as an investor, the means to scale your portfolio and generate more income.
Here's what you need to know about leveraging the equity in a property to expand your real estate investment holdings.
How to use your property's equity
Tapping into the equity in your property isn't as easy as going to the bank and withdrawing cash. However, this doesn't mean it's inaccessible, provided you've accumulated enough equity to leverage it to your benefit.
Leverage in a real estate sense refers to using a combination of equity accrued in a property in conjunction with debt – in this case, a home loan – to purchase an investment property. This financing strategy can be very effective for investors with significant equity built up, either in one property or across several, to make new investments without the hassle of taking out loans to purchase a new property.
Building up equity
Unless a property was purchased with a significant down payment, many new investors don't have access to enough equity to use it in making another property purchase. As such, taking time to allow equity to accrue can be very important.
This process can be slow for a real estate investor making monthly minimum loan payments, but there are ways to accelerate accumulation, including:
- Making larger payments or more frequent payments
- Making property improvements that will drive up the value of the home
- Refinancing to a shorter loan or a loan with a lower interest ratev
Starting with a large down payment is always ideal, but many real estate investors can't access those resources from the jump. Some of these options may not be possible, particularly for newer investors without the assets to build equity quickly. If this is the case, making payments slowly and waiting to make future investments is okay.
How a property rehab can help build equity
Making significant updates, upgrading and renovating the home can also help you to add value and increase profits. When a real estate investor purchases a property for a fix and flip, the process usually involves buying a distressed property in desperate need of an overhaul. When the rehab is complete, they immediately sell the property to reap the reward of a higher-valued home.
In buy-and-hold investing, you also purchase a fixer-upper at a reduced cost and improve it to increase its worth. Rather than immediately selling, however, you keep the property for a period of time as a rental. This allows the property to gain more equity while also providing you with a source of regular monthly income from renting it out.
In a short-term buy-and-hold, you typically hold the property for about five years and then sell it for a profit after it’s appreciated in value. You can then take the equity gained to purchase another investment property.
Determine the right way to access equity
There are a few different ways to access equity in a rental property, each with its own unique pros and cons. Before determining a path, make sure you understand your options and how each may benefit your financial situation.
Cash-Out Refinance
As the name implies, a cash-out refinance is a way to extract cash from an investment property loan by refinancing for a higher amount. The difference between the first and second loans will be available in cash for investors to do with what they'd like. This can be the hardest option to execute, as financing an investment property differs from a primary home but offers investors the most flexibility. In addition, there are no tax consequences on the cash obtained, making this outcome highly beneficial.
Home Equity Line of Credit (HELOC)
A HELOC is a way to use the equity in your property as a line of credit, similar to a credit card. HELOCs can be used to make property improvements invest in new properties or any other applicable investing activity. HELOCs, rather than operating solely on the equity in a home, have a maximum draw amount, as well as a time period to draw credit and a time period to repay.
A HELOC's revolving line of credit functionality is especially appealing to many investors. There is no fixed loan amount, as is commonly the case when borrowing against equity outright. Credit can be used as needed for many investment-related expenses.
Home Equity Loan
A home equity loan is similar to a HELOC, but instead of a line of credit, equity is borrowed in the form of a basic loan. This loan can be equal to the amount of equity built up in a property and then must be repaid on a monthly basis, similar to any other home loan. This method is simple and straightforward, with the initial lump sum amount accessible for a down payment on a new property.
The benefits of accessing equity
If you're considering leveraging equity in your investment properties, there are numerous benefits to be had.
Consolidate debt
Too many loans in too many places isn't always a good thing, especially when you have additional borrowing aspirations in the future. Using the equity in a property to pay down other debt sources keeps your debt in one place, making it easier to manage what you owe and to whom. This can also make it easier to obtain additional loans in the future.
Capitalize on market conditions
When the market is hot, or you see a perfect property, being able to buy without delay is a big deal. When there's no cash left to pay for a new investment, using home equity can ensure you don't miss out on a premium property due to a lack of liquidity.
Easier borrowing conditions
In general, getting approved for a loan on an existing property, like a home equity loan or a refinance loan, is easier than getting a new loan, especially as an investor. If you need a loan quickly to make a purchase, leveraging equity can often yield faster results than putting in an offer and applying for an investment property loan after the fact.
More buying power
When you take out a loan against your home equity or refinance to cash out, the result is cash in your pocket to put down on a new property. If the cash you have on hand is significant, this can be a big benefit because, as far as a seller is concerned, you can purchase in cash, not jump through the hoops that getting approved for a loan can take, especially traditional home loans. This makes you a better candidate off the bat, making it easier to be the winning bid on a property.