How to Leverage Your Home For Investment
Leverage is a scary word to many people, conjuring up complicated real estate deals. Simply put, it means using other people’s money (OPM) to make money. Sounds pretty good, right?
One of the most famous real estate tycoons is Donald Trump, a New York entrepreneur who continually leverages his net worth to buy fancy New York hotels as well as other landmark buildings. Not all of Trump’s investment ideas are profitable, and these surely hit the news on a recurring basis, causing people like us to question our ability to make money in real estate.
Leverage should not be feared. Sure, there is always risk in any investment, but leverage is one of the most exciting and profitable ways to make money. The pros know this and do it all the time. You can take advantage of the power of leverage, too. It’s not a simple task if you’re a beginner, but the payoff may be well worth your efforts.
First, you should try to determine what your house is worth in the current market. You can do a comparative analysis yourself or hire a professional appraiser. That way, you have an amount you can safely use for investment purposes, real estate or otherwise.
If you still owe on your home, with a primary or first mortgage, your banker may offer you a second mortgage based on your equity. Equity is the difference between what your home is worth and how much you owe on it. These loans come in two forms: home equity loans and home equity lines of credit (HELOC) loans. Be prepared for higher interest rates than your primary loan because the bank is taking on more risk. In the event of a foreclosure, these loans take a “second” position, meaning your first or primary mortgage will be repaid first. Still, this interest rate will be lower than a credit card. Keep in mind that with either of these loans, the more you borrow, the higher your monthly payments are. Be cautious that you don’t get “upside down,” where your new investment loses value and you can no longer make your loan payments. If this happens, the bank can foreclose on your house. People generally take out home equity loans to pay for a specific, one-time cost but use HELOC funds over a period of time.
Another option is a cash-out refinancing, where you refinance your existing or first mortgage and also borrow an additional sum from your equity at the same time. This gives you cash that you can use for investment purposes as well, and it is the only type of refinance where you can actually use your home equity. You should carefully consider this option; depending on the new interest rate and how much cash you take out, your mortgage payments could increase. Make sure your new investment can handle the additional payment. Your banker can assist you in calculating how much your new loan payment will be, but generally, it depends on the value of your house and the banker’s maximum allowed loan-to-value (LTV) ratio. Some lenders let you refinance up to 100 percent of your home value, but you may have to pay private mortgage insurance until you rebuild 20 percent equity.
Another popular form of leverage for people today is called a reverse mortgage. Directed at seniors with limited incomes and a significant amount of home equity, this tool allows you to take the equity out of your home without selling it or making any more payments. It’s the “reverse” of a typical mortgage, in which you make payments each month, increasing your equity and decreasing your debt. With a reverse mortgage, the lender pays you, reducing your equity and increasing your debt. As long as you live in the house, you do not have to pay back the mortgage. There are also requirements to qualify. Whoever is listed on the title must be 62 years old or over, live in the home and have equity in the home. Reverse mortgages can also be costly for you as well as for your heirs. But thousands of seniors are benefiting from them today.
And, of course, there is also the option of securing a first mortgage on your house if it’s already paid for. You can apply for a loan and use the cash proceeds, which is an excellent way to leverage your home for investment.
Finally, consider selling your house. You can purchase a less expensive one and take the remaining cash for your investment. Seldom do people realize how lucrative this can be, especially if their house has greatly appreciated in market value.
Whatever option you choose, it’s important to think carefully and seek professional guidance before putting your house on the line for any investment. But if you’re convinced that your new investment will have the ability to make the new payments and offer you peace of mind, then leveraging your home may be a wise financial decision. HLM
Sources: interest.com, investopedia.com and wikibooks.org.