Using the equity in your home means utilizing the money that has grown as a result of your homes increased value, which can be used to invest in real estate.
Can you use the equity in your home for real estate investments?
Property is undoubtedly a beneficial investment. Still, people dream of growing their property portfolio but don’t really know where to start. Or, worse they lack the initial funds. Well, this is where this article can help, as we will help to explain how you can use equity in your home to invest in real estate throughout Canada. Fortunately, this process is easier than you may think. Hopefully, we can help you get started on your investment journey.
Leveraging your equity into real estate
We’re sure that if you’ve found this article, then you’ve been thinking about how to start your property portfolio. As we mentioned in the introduction, money tends to be a roadblock, but this isn’t necessarily true. What we mean is, that just because you don’t have access to the “funds” to start making lucrative property investments. Basically, there is a much easier, less daunting method that you can use to grow your investment properties.
Yes, investments for a beginner can be extremely overwhelming, and confusing at times. However, in this article, we want to demonstrate how more debt can sometimes result in more money. If you’re now scratching your head thinking, how? Well, continue reading, and we’ll be able to make this much clearer. We’ve tried to simplify the steps, so they’re basic, easy to follow, by using understandable vocabulary. So, we can hear you asking: can more debt actually mean more money?
Is all debt the same?
Generally, like all things in life, there’s good and bad – and debt is not exempt from this rule. When people hear the term “debt” they instantly jump to the negative connotations that have been historically associated with borrowing. Now, as you know, if you already have a mortgage, then that’s an example of “good” debt. What we mean is that good debt, like mortgages, student or investment loans can eventually help you to increase your net worth.
Now, we get to the “bad” debt. Bad debt is typically associated with people borrowing funds to pay for everyday costs, emergencies, etc. Some examples include credit cards, loans, payday loans. The differentiating factor between “good” and “bad” debt, is that good debt has longevity, lasting value. Whereas, bad debt, can look aesthetically pleasing, but it doesn’t necessarily add value to your investment portfolio (or credit history). So, yes, bad debt even when paid on time, can increase your credit rating, but it will not have the same advantages of “good” debt.
Equity: What is it?
Equity is generated for the length of time that you own a property. So, let’s say that you purchased your home for $400,000. You have now lived in the property for over three years, and you’ve paid off $150,000 from the original mortgage amount. Not only that, your home has increased in value by $200,000 since your purchase.
Thus, from this scenario, your home if we were to use the fair market value is $600,000. What’s more, is that fair market value is the amount that you would receive if you decided to sell your home. If you take this route, the $600,000 will be split, to pay off the remaining mortgage, realtor fees, etc. Then, you will be left with $350,000 equity – which is your money, from this beneficial investment. So how to you use equity in Your Home to Invest in Real Estate?
What is leveraging?
Hopefully, this example has highlighted, why a mortgage or property is an educated investment, through good debt. To put it simply, leveraging means to borrow money to increase the chances of receiving a lucrative return on investment. But, when it comes to using the equity in your home, it’s even easier. The simplest way to do this is by borrowing funds against the fair market value of your property.
As we tried to explain in the example, your property will generally increase in value from the date of purchase. Yes, you might still have a hefty mortgage, but this doesn’t mean that you cannot access the equity in your home. In fact, with most lenders and banks, you can borrow up to 80% of the fair market value – minus your outstanding mortgage properties. So, in a nutshell, leveraging the equity in your home, is an educated and beneficial investment.
How can you obtain leverage?
Right, so if you’re still interested in how you can use good debt, to make more money, we’re sure that you want to know how you need to get started. However, what it comes down to isn’t how you can acquire leverage. Instead, it is how you can make an equity leverage work for you. As mentioned, most lenders and banks will work on this formula:
Fair Home Value minus Outstanding Mortgage Balances equals the amount that a lender will borrow you.
Leverage by Using your Home Equity Line of Credit
Likewise, you now need to know how you can make this work for you. Really, all you need to do is approach your bank or current lender to ask for a HELOC (Home Equity Line of Credit) loan.
So, using the first example, we’d like to demonstrate the benefits of leveraging your property’s equity. Although, we’ll be using cash (outright) vs leveraging scenario.
- Cash: Purchase a property of $500k
- Leveraging: Purchase a $500k property using $400k loan and $100k cash
The question now is, what happens when the property value increases to $600k after one year?
- Cash: Return on equity approximately equals 20% (which is a $100k increase in the initial investment).
- Leveraging: Return on equity will be 100%
Therefore, by utilizing your equity leverage you do not require as much cash up front, you also receive a higher return on equity – five times more to be more precise.
The Bottom Line
Ultimately, when this method is used correctly and is well thought out, it’s a highly profitable investment. Not only that, as your property portfolio grows, the CRA (Canadian Revenue Agency) grants deductions on taxes based on the interesting part of your property’s mortgage. So, really, looking at it from that standpoint, this method is win-win.
Although the setting up your property portfolio in this way is relatively simple, we do need to mention that the more properties you have, the math can become complicated too. However, the basic idea and the bottom line is: more leverage equals more equity equals more money in the long run.
Want to explore the opportunities possible by using your homes equity to invest in real estate? Email or call me at email@example.com / 416-739-7200.
Ilan Joseph is a Real Estate Broker with Sutton Group and is co-founder of a 10-person award-winning Toronto, Thornhill and Vaughan real estate team. Since 2002, Ilan has been privileged to advise and service thousands of buyers and sellers, enabling them to reach their real estate goals.