What is Equity?
The longer you hold a property, the more equity it will earn. The best way to understand this is to use an example. A family friend of mine bought a home in Markham for $300,000 in 1986. In 2019, they still had a balance of $100,000 (they refinanced a few times), however, since 1986, the fair market value of the home has increased to a staggering $1.2 Million! If they decided to sell their home the equity is calculated by subtracting their remaining mortgage of $100,000 from the current value of the home of $1.2 Million. My family friend is sitting on equity of $1.1 Million!How to Use a HELOC for Investment Purposes
The strategy is basic and I’ll try to explain it as simply as I can. If you are one of the lucky ones to be sitting on a large amount of equity from your current primary residence then you have the opportunity to utilize it for investment purposes. You would use your HELOC to make a down payment, as well as utilize a mortgage to cover the rest of the cost to purchase an investment property. The goal is to put that money into an investment property that you rent out for an amount that covers the costs of borrowing + monthly expenses (HELOC + Mortgage + taxes, insurance, etc.). The longer you hold onto that investment property and have a tenant pay your mortgage for you, conceivably, in 20-25 years, you will have a fully paid off property with hopefully the added benefit of an appreciation in value. Now, instead of just your primary residence paid off, you will have two properties paid off, which can only mean more money for your retirement when you decide to sell! Now, just imagine if you had 3 or 4 investment properties all doing the same thing. I know, it sounds simple, but in reality, finding properties that are cash flow positive from day one are difficult to find, but if you do find one (with my help, of course!) it can be one of the best investment decisions you will ever make. All you need to do is start with one. Once you get the hang of it, you can start the process over again and keep growing your wealth and equity in each property over a long period of time. I like to call it the “Get Rich Slow” scheme.Something to Consider Before Using a HELOC to Invest
Like every theory, there is always a way to poke a hole through them. Here is something to consider: Since you will be using both a HELOC and a Mortgage (essentially “other people’s money” since you technically aren’t using any of your own), it can be risky for the simple fact that you won’t have any actual equity in the property you buy. You are purchasing a property with 100% debt so if the proverbial bubble burst and the investment property you bought reduces in value then now you are what they call a “Negative Equity Situation.” In some ways though, it’s not really a negative because the only way you lose is if you decide to sell the property at a loss. If your mindset is focused entirely on holding the property over the long term and renting it out to a tenant who pays rent that covers all your mortgage and expenses, then that’s not a negative. That’s positive! Don’t sell and you won’t have a problem.Using a HELOC to Purchase a Pre-Construction Condo
Let’s use the example from my family friend who is sitting on $1.1 Million in equity for their home in Markham. They have identified a pre-construction condo priced at $500,000 that they are interested in buying and want to put down 20% = $100,000. Instead of using their own cash, they decide to utilize a HELOC and access the funds for the deposit through their line of credit. Since a typical pre-construction condo takes three to four years to build, my family friend will use that time to pay back the amount he withdrew from his HELOC from his existing income. The reason he does this is so that when construction is complete and it’s time to close on the condo, he will have equity in it immediately. The good news is, if he purchased the right condo, in 4 years while the condo is being built, it would have appreciated in value from the original purchase price giving him even more equity! If you do this properly then one property turns into two, and two properties turn into four. Each time you are either refinancing or selling depending on how much equity you have in each unit.Using a HELOC to Purchase an Existing Condo
My family friend is now interested in purchasing an existing condo also priced at $500,000. He gets a HELOC to put down 20% ($100,000) and at today’s HELOC rates (approx. 4.45%), this will cost him around $4,450 each year in interest. The thing to remember is that each year he is paying $4,450, the investment property will be increasing in value as well. Let’s just say in 5 years, my family friend has paid $22,250 in interest payments, but during this time, his $500,000 condo has also appreciated in value by 5.5% each year. Do you know what his condo is now worth in 5 years?$653,480
That’s an increase in value of 30.696%! Yes, he has to pay $22,250 in interest payments, but by doing that he was able to purchase a property that is now worth $153,480 more than what he paid for it. I would think that’s a trade any person would consider making. The added benefit of this is that the interest you pay from the mortgage on your investment property is deductible. Whether you decide to purchase a pre-construction condo or an existing condo as an investment, the same rules apply. Always think long term because having a long term strategy can develop real wealth.If you have any questions about utilizing the equity in your home call, text, or email me anytime!
