Over the years, I’ve met a good number of people who expressed a desire to invest in real estate but felt held back by a lack of funds. However, in most cases, it turned out that the key to breaking down their financial roadblock was actually the home they were living in. The solution was right in front of them; they could tap into their home equity to buy a rental property.
As I always say, you can’t eat equity, so why just let it sit there when you can put it to good use and boost your cash flow in the process. Now, with all that said, we’ll get straight to the point with the question below:
How can I use home equity to buy a rental property?
Investors can tap into home equity by utilizing the following three financial products:
- Home equity line of credit that starts with a zero balance
- Home equity loan structured as a secondary loan that offers a lump sum
- Cash-out refinance that replaces the original home loan and provides the investor with usable cash
Now, let’s take a deep dive into the above options for pulling equity out of your primary residence. This way, you’ll be able to decide for yourself which is best for your particular situation.
Three Ways to Leverage Your Home Equity to Buy a Rental Property
We’re going to find out what a cash-out refi is, along with how a home equity loan works, and then we’ll jump into the ins and outs of a HELOC.
But first, I’d like to cover a few points…
Unlocking the value built up in your home is an incredibly effective approach to acquiring rental real estate. It’s a strategy I’ve been utilizing for years, so as you can imagine, I’m very familiar with the various funding options that allow you to pull equity out of a property.
However, if you’re not 100% familiar with this topic, I’ll give a quick definition. Equity is the difference between your property’s value and the amount you currently owe on your mortgage, and this difference can be tapped into. It’s more than that, though; it’s a powerful financial tool that, when used wisely, can be leveraged to generate great wealth and financial independence.
How do you build equity? The most common ways are paying down your mortgage or increasing your property value. If you’re interested in learning how to speed up the mortgage payment process to increase your equity, then be sure to dive into my book that you can pick up on Amazon; it’s called How to Pay Off Your Mortgage in 5 Years.
Ok, it’s time to discuss the three options that allow you to easily grab equity from your home.
1. Convert Equity into Usable Funds with a Cash-Out Refi
A cash-out refinance is an option that can turn your home equity into usable cash. How does it work? Well, you replace your existing mortgage with a new home loan in an amount that’s more than what you currently owe on your house. The amount in excess is actually the home equity that you’ve built up. The money from the refi is then used to pay off the original loan, and you keep the difference.
Although it varies from lender to lender, you can typically only refinance up to 80% of the home’s value. That said, let’s find out how the numbers work together in a cash-out refi.
In this example, we’ll say your home is appraised at $200,000, and $100,000 remains in what’s due on the mortgage, leaving you with $100,000 in equity. With the 80% loan-to-value ratio in play ($200,000 x 80% = $160,000), your new loan amount would be $160,000, and this is used to pay off the original loan, which is $100,000, leaving you with $60,000, minus any closing costs, that can be used to invest in real estate.
Receiving a large lump sum of money can sound attractive, but just remember, you’re refinancing, which means that if you have a lower interest rate locked in with your existing mortgage, you’ll lose that good rate and be assigned a new rate that reflects today’s economy where interest rates are much higher. Plus, as soon as they hand you a check, the clock starts ticking and the interest starts accumulating.
2. Take Out a Home Equity Loan to Purchase Real Estate
Unlike a cash-out refi, a home equity loan doesn’t cancel out your original mortgage. Instead, a second loan is taken out against the equity in your home, and again, it’s typically around 80% of the value. Once approved, you’ll receive a check for a lump sum amount that can be used to invest in a rental property. Also, the loan terms are completely separate from the original mortgage, and will most likely have a fixed interest rate that would be higher than what a cash-out refi would offer.
There are a few things you should keep in mind when taking out a home equity loan. The first is that because it’s a second loan, you’ll have two loan payments that you’ll be responsible for. Additionally, once the money is dispersed, the interest timer starts.
3. Utilize a HELOC – Best Option for Tapping Into Equity
Ok, now I’ll cover what I consider the best option for pulling funds out of home equity to buy a rental property, and this would be a home equity line of credit (HELOC). As the name suggests, this avenue for funding a real estate purchase is basically a line of credit that pulls from your home’s equity.
A HELOC is the key to transforming idle equity into a useful resource you can easily tap into, fueling cash flow and opening up a world of financial possibilities in the process. It works like a traditional credit card, providing you with the flexibility to borrow from your home equity up to your pre-approved limit, repay the borrowed amount, and then access the funds again, when needed.
You’ll have about ten years to draw off the funds, and the timeframe can vary with each lender. During this time, you’re normally only responsible for making payments on the interest. After the draw period ends, the game changes, and you transition into the repayment phase, where you begin to pay down the principal as well.
What makes this the preferred avenue for accessing home equity to buy a rental property is that your balance begins at zero, meaning you start your investment journey without owing a dime in interest. In contrast, with a cash-out refi and home equity loan, from day one, the books will show that you owe thousands of dollars, with the interest accrual clock starting and the loan balance increasing.
Overall, a HELOC is the best option if you decide to pull equity out of your main residence and apply it to the purchase of a cash flowing rental property.
Power Resources for Real Estate Investors
Whether you’re buying your first rental property or you’re a seasoned professional purchasing your 10th, continually expanding your knowledge is always a wise idea. With that said, below, you’ll find our top resources for growing your portfolio and becoming financially independent:
- The Financial Freedom Academy
- Freedom Number Cheat Sheet
- 90-Day Financial Empowerment Bootcamp
- Morris Invest & SDIRA Program Overview
Turning Home Equity Into a Profitable Real Estate Investment Opportunity
If you have a good amount of home equity to work with and you’re contemplating making a rental property purchase, the timing couldn’t be better. With mortgage rates lowering and a housing shortage among us, it’s setting the scene for property prices to explode this spring. So, if you invest now, you can grab a property at a lower price and capture equity when the prices rise. In addition to this, rental rates are also increasing, which will set you on the path to increased cash flow. Here are a few related articles on the topic that I know you’ll find interesting:
- Investors Buy to Secure Equity as Home Prices Rise
- Driving Factors Behind the Ability to Charge Higher Rent
- More People Renting Indicates Financial Security for Investors
If you’re ready to take the next step and invest in a lucrative rental property, or even if you feel you’re not quite ready, schedule a complimentary call, and we can explain how everything works, provide information on additional funding methods, and create a custom investing plan that works with your unique situation.
At Morris Invest, we take care of all the details for our clients. We even place a reliable and vetted tenant in your new rental property; this way, you won’t have to search for one yourself. The bottom line is that we make it super simple for you to become a real estate investor and are here for you every step of the way.
Make sure to dive into this video that goes into even more detail on ways to take advantage of your home equity:
Ready To Build Passive Income Through Rental Real Estate?
Ready to talk about your goals? We're here to show you the tools and teach you the process to begin earning legacy wealth for you and your family.