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Using Equity in Home to Invest in Real Estate – Here is how it is done

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Using equity in home to invest in real estate - here is how it is done

Homeowners in good old T-Dot are at an advantage; their homes are now pricier than those of Vancouver. This advantage comes in when they have a home to buy after selling the home they own. The value of the home they own is the equity they can utilize.

Should Torontonians owning homes and having the finances needed for purchase of an investment property be able to leverage home equity to acquire an investment property in the city? The answer is yes. They should learn to do so. Also, it may be surprising to some but using equity to purchase an investment property in not just Toronto but in the whole country is easy and possible.

How can Canadians use equity to purchase investment property in the country?

Every Canadian dreams about it, the thought of where they could invest their money if they had it, that is. They think about what they would do with it one day. Most tell themselves they will save enough to invest soon or maybe later.

Everyone loves to dream and everyone dreams about the thought of where they would invest their money once they had it. Some dream vividly of luxury, a big house, parties and cars whereas some are dreaming of an affluent yet responsible life.

Is there an easier way to do all this? It should be known that investing does not need to be a hard and overwhelming task. Whether Canadians are using their home’s equity to buy another home in Canada or using it to purchase a property to put on rent, the idea and concept of leverage is in reality quite simple instead of being complicated.

In this post, how to leverage equity in a home or an investment property with a home equity line of credit (HELOC) and how that will equal more wealth in the long run, will be explained nicely. More debt can mean more money.

We are breaking down a few simple concepts (with a healthy dose of vocabulary) to help people understand easily the potential of revenue generation in their existing home investment. Let’s read one.

Why should Canadians maximize the value of their home’s equity?

Home equity in simple terms is basically the amount of money the home is making for its owner. It is quite simple. As the property purchased by anyone appreciates in value over the years, it technically becomes worth much more than what they paid for it.

However those who wish not to sell their home, they can still use its value it generated over a period of time to purchase another property.

If sellers wish to, they can use their home’s appraised value to make the down payment for another property, either for a vacation home or for purchasing a rental property. Both are attractive options and in the current scenario, the latter sounds like a more attractive option.

Using the equity in the home to invest in real estate and generating more returns make economic sense instead of simply letting that added value go to waste by just letting it sit in the vault or in the bank account. Of course that account can be put in a term deposit and mutual funds, but the prospects of real estate investments are much more lucrative and attractive.

Some people use home equity to purchase a second home or a vacation home to have a good time. The former is for investment purposes. But before anyone actually starts using their equity, they should carefully weigh in their options regardless of whatever they are purchasing to generate a steady stream of rental income.

Those who are looking to purchase a rental property should remember that condos are one the best properties to generate the best returns on the investment. Current scarcity in the housing market has led to a sharp drop in vacancy rates which can lead to strong appreciation in prices of condos.

No matter the kind of housing options buyers are considering, buyers must always be sure to get an estimate of the price of the property they’re looking to buy with the equity in their home. Now let us examine some equity terms closely.

A comparison of Good Debt and Bad Debt

Debt generally does not sound good. However, it should be understood that good debt increases an individual’s net worth as well as helping generate value (i.e. taking out a mortgage, borrowing student loans or accessing a line of credit for debt consolidation), or either.

WHereas bad debt usually uses borrowed money (payday loans, credit cards etc.) for the purchase goods or services that may have no lasting value. Among such goods are sports cars.

No reader should be misunderstood. Everyone loves sports cars, video games, gaming consoles, gaming computers, toys, dolls, doll houses, action figures and a lot more related stuff. From an investment viewpoint however, they won’t bolster anyone’s financial portfolio.

Home Equity – what is it?

The longer a person holds a property, the more equity it earns. For instance, let us suppose a person has purchased their current home for C$ 300K. After purchasing it, they have managed to pay C$ 100K towards their mortgage. The property thus appreciated in value by C$ 150K over the previous few years.

The fair market value (FMV) of the home will thus be C$ 450K. The equity in that property is the amount the homeowner would receive if they decided to sell their home and pay off the remaining mortgage. In this matter, the equity is equal to C$ 350K (The FMV of 450,000 subtracted by the remaining mortgage of 100,000).

What is Leverage?

Up to now, everyone has established that investing in a mortgage does in fact make the equivalent of good debt (something each sensible Canadian is after). Now it is time to examine leverage. In simple terms, it denotes the use of borrowed money for raising the potential return of an investment.

Keeping this in mind, using leverage in real estate is quite easy. Anyone can leverage their home’s equity by borrowing funds on the fair market value of their current home.

Chances are that the home has increased its value since it was last purchased. WHile the homeowner may have paid only a portion of their mortgage, they still are able to borrow up to 80% of the fair market value of their home without any outstanding mortgage. Leveraging the equity in their home into additional residential properties is hence key.

Leveraging for Equity

To showcase effects leverage has on equity, Let us use the previous example split in a cash vs leverage scenario:

  • Cash option: Purchasing a home of C$ 400K using cash.
  • Leverage option: Purchasing a property of C$ 400K with a loan of C$ 200K and cash of C$ 200K.

If and when the price of the property rises to C$ 600K the following year, here is what happens:

  • Cash option: Return on equity = 20% (A rise of C$ 100K on an investment of C$ 500K).
  • Leverage option: Return on equity = 100% (a rise of C$ 100K on an investment of C$ 100K).

By using leverage, not only does the homeowner outlay less cash but also receives a much higher return on equity.

Using Home Equity to buy real estate by obtaining leverage

So, by now a lot are probably thinking that the leverage business makes sense, but there is one question: How do they make it work?

When someone owns a property and has equity built into it, they are allowed to leverage home equity (i.e. borrow that home equity, indicating that mortgage providers will let people refinance around 80% of their home’s market value) for a nominal interest rate.

Using the Home Equity Line of Credit (HELOC) as a means of leverage

As mentioned above, it is easy to obtain leverage if a homeowner has amassed equity in their home or a property that they already own. THey simply need to approach their bank for a HELOC loan. This can then be used for leveraging their home equity to purchase another home for rental, vacation or investment purposes.

Now let us take the example of a C$ 400K and say the homeowner owes C$ 200K on their mortgage; the homeowner can still borrow C$ 200K at roughly 3% interest which in over five years can amount to C$ 30K.

Using a HELOC to purchase investment property

At this point, a person can still invest that C$ 200K into a rental property. THis will accumulate its own equity over time to make a lot of money (more than the C$ 30,000 made earlier) which can be used to pay the interest on the first loan.

Also, the Canadian Revenue Agency (CRA) allows homeowners to deduct the interest portion of their investment property mortgage from their taxes. This creates a win-win situation.

In this option, the more properties a homeowner adds, the more complicated its math becomes. Hence, the idea is more leverage = more equity = more money in the long term.

Through usage of leverage, the homeowner raises their ability to buy high value investment properties which subsequently raise the net gain as property values rise.

Home Equity Loan versus Home Equity Line of Credit (HELOC)

The difference between a Home Equity Loan (HEL) and a Home Equity Line of Credit (HELOC) sounds complicated but it isn’t like that. It’s simple. A loan is a fixed amount of money in one lump sum paid upfront. A homeowner will start paying interest on the loan the moment they take it out.

Experienced homeowners suggest using a HELOC because homeowners only pay interest on the funds they use. THis makes a difference when it comes to purchasing a pre-construction condo with borrowed funds.

Unlike resale condos where a 20% upfront payment is demanded, pre-construction condos have payments paid in installments. Usually 15% in three installments over the first year with the final 5% paid approximately 4 years later upon completion.

Conclusion

Here is how experts have broken down how homeowners and prospective investors can benefit from borrowing money and leveraging a property instead of paying cold hard cash down. Yet, those who are facing confusion should contact their trusted realtor right away.

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