Friday, 13 December 2019 00:59

How to Leverage Home Equity to Fund a Rental Property Loan

How to Leverage Home EquityOnce you get a decade or two of homeownership under your belt, you learn a lot about the market. There are plenty of ways to get liquidity to fund your next business venture. Home equity is the big one though.

Home equity is something everybody looks forward to. It’s actually an “insider secret” realtors use too. Mastering the real estate market, stock market, or any other market really is all about buying as low as possible and refinancing as high as possible.

It’s also the easiest way to turn one home into two. This gives you the flexibility to do things like have a summer home in the Midwest and a winter home in Arizona or Florida. Of course, two properties means two bills, and that’s just going to make paying for everything even harder. You’re not the first to come across this conundrum.

 

The trick is to furnish both homes, keep personal items on you, and rent the other out as a vacation property. Or if you’d rather just stay put in your neighborhood, you can turn your second home into a rental property. With marketplaces like Airbnb, Craigslist, and Couchsurfing offering so many alternative ways to rent, there’s no better time to get a rental property loan.

What Is Home Equity?

Home equity is usually any homeowner’s most valuable asset. It’s the difference between the value of a house and the amount you owe on it. When you buy a house for $150,000 and put 20 percent down, you’re taking a loan for the remaining $120,000. This, along with the terms of repayment and the lender’s recourse for default (i.e. foreclosure), makes up the terms of your mortgage.

If your home goes up in value over the next 10 years to $200,000 and you’ve since paid $20,000 to your principal balance (not including interest, PMI, taxes, etc.), then you now have $100,000 worth of equity. 

In 2019, we are in a market where home prices are high, so people should be able to pull out a lot of home equity, even if it was already done before. There are a lot of ways people pull equity out of property.

They fall into several categories and affect your credit in different ways, so pay attention. Equity is pulled out as either a line of credit, junior loan, or refinanced loan. Each is a completely different way of pulling equity and has different pros and cons, since they all use your house as collateral.

Let’s dive into each one to understand a bit more about the differences.

What Is a Home Equity Line of Credit (HELOC)?

A home equity line of credit (HELOC) works very much like a credit card account. This is both in function and on credit report. When you are extended a line of credit for this $100,000 in home equity, what the lender is doing is giving you that limit to purchase whatever you need. 

HELOCs are the very easy way to get quick cash, but in doing so, you’ll get a secondary interest rate on a secondary loan. When you sell your home, the HELOC is paid first. If your home is no longer worth $200,000 (or even $150,000) when you sell, you’re going to be stuck in your home with the bank holding all the equity. At that point, you may as well have rented that entire time.

Banks offer HELOCs because they do not want you to leave as a customer. If you are responsible as a spender and pay down the balances quickly, HELOCs can be very beneficial for emergency repairs and other issues. But just because you have $100,000 available in a HELOC doesn’t mean you need to spend it. This is different than a junior lien.

What About a Second Mortgage?

A second mortgage is a junior lien. This functions and shows up on your credit report as a loan. Much like your student loan, the money from a junior lien is available immediately. If you are going to invest money in something (i.e. a second home to use as a rental property), a second mortgage may be the way to do this.

It’s important to know that a second mortgage is closed-ended, so once you spend that $100,000, it’s gone. This is different than the open-ended HELOC, which will continuously replenish as you pay.

Not only will taking a second mortgage give you literally a second mortgage payment, but if the rental property you buy costs more than $100,000, you’ll actually have three. It gets risky and expensive fast. This is why most people choose to refinance, even if a HELOC and 2nd mortgage is involved.

What Do I Need to Know About Refinancing?

When you refinance your mortgage, you’re basically cleaning up all the paperwork from all the junior liens and lines of credit to give you a realistic picture of what you owe and get it back to one sensible payment. Of course, it’s not always used for bad things.

Refinancing your loan at the height of the market instead of pulling out a HELOC or second mortgage in the first place gives you instant cash up-front while saving a ton of money in payments.

It renegotiates your loan into lower interest rates based on prior payment history, equity, and current market conditions. 

Even better, refinancing your mortgage to fund a rental property loan in this market is the best possible timing to maximize potential growth. Talk to any loan officer or mortgage broker, and they’ll tell you that 2020 is the year to own a rental property. If you don’t already have one, consider refinancing your home and buying your dream rental property.

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