HOW TO USE HOME EQUITY TO BUY INVESTMENT PROPERTY IN CANADA
You can easily leverage home equity for whatever purpose you choose. Personally, I prefer lucrative investments that turn into exponential returns when using borrowed money.
We all dream about where we would invest our money if we had it. We think about what we would do with it one day. We tell ourselves, I’ll save enough to invest soon. But what if there was an easier way? Investing does not need to be such a daunting task. Stick with us and we’ll show you how more debt can actually equal more money.
Whether you’re using the equity in your home to buy another home in Canada or you’re using home equity to buy another home or a rental property in Canada, the concept of leverage is actually quite simple. In this article, we will show you how to leverage the equity in your home or investment property with a home equity line of credit, and how that will equal more wealth in the long run. More debt can equal more money! We’re breaking down a few simple concepts (with a healthy dose of vocabulary) to help you better understand the revenue-generating potential in your current home investment. Read on or watch the video below to learn how to use equity to buy a second home in Canada.
Why Maximize the Value of Your Home Equity?
Home equity, in simple terms, is the money your home is making for you. As the property you bought appreciates over the years, it becomes worth much more than what you paid for it. Even if you don’t want to sell it, you can still use the value it has generated over a period of time to purchase a second home. You can use your home’s appraised value to make the down payment for another property, be it a vacation home, a second home, a rental property or otherwise. Using the equity in your home to invest in real estate and generating more returns makes more economic sense than simply letting it sit around and allowing that added value go to waste.
Some people use home equity to buy a second home in Canada or vacation home for recreation while others do it for investment purposes. In any case, before you actually use your equity, it’s important to carefully weigh your options, whether you’re buying a vacation home or a property to generate a steady stream of rental income. If you are looking to buy a rental second property, remember that a condo will give you the highest returns on your investment. Currently, scarcity in the housing market has led to low vacancy rates, which in turn has led to a good appreciation of condos (more on this in the last section). No matter what type of housing option you’re considering, be sure to get an estimate of the price of the property you’re looking to buy with the equity in your home. Next, we deep-dive into the topic by taking a closer look at some of the equity terms.
Good Debt versus Bad Debt
Although debt carries a negative connotation, there is such a thing as good debt, too. In general, good debt increases your net worth and/or helps you to generate value (i.e. taking out a mortgage, borrowing student loans or accessing a line of credit to consolidate debt), while bad debt typically uses borrowed money (i.e. credit cards, payday loans, etc.) to purchase goods or services that have no lasting value, like a fancy car or material items you don’t plan on reselling. Don’t get us wrong, we love toys and shiny things as much as the next person, but from an investment standpoint, they aren’t going to bolster your financial portfolio. Good debt isn’t something to worry about financially, and can actually be a great asset if used correctly.
What is Home Equity?
The longer you hold a property, the more equity you will earn. For example, let’s say you bought your current home for $400K. Since buying it, you’ve managed to pay $150,000 towards your mortgage and it has appreciated in value by $200K over the last few years. The fair market value (FMV) of your home will be $600K. The equity in your home is the amount that you would receive if you decided to sell your home and pay off the remaining mortgage; in this case, the equity equals $350K ($600K (FMV) minus $250K remaining mortgage).
What is Leverage?
So, now that we’ve established that investing in a mortgage does in fact equal good debt — which is the kind we’re after — let’s talk about leverage. In simple terms, it means to use borrowed money to increase the potential return of an investment. So with that in mind, how to use leverage in real estate is actually quite easy. You can leverage the equity in your home by borrowing funds on the fair market value of your current home. Chances are your home has increased in value since you purchased it. While you may have only paid down a portion of your mortgage to date you are still able to borrow up to 80% of the fair market value of your home, minus any outstanding mortgage due. Leveraging the equity in your home into additional properties is the trick. More on that later.
Two Peas in a Pod: Leverage for Equity
To demonstrate the effects of leverage on equity, let’s use the example above, but split it into outright cash vs. leverage scenario:
• Cash Option: Buy a $500K property using all cash.
• Leverage Option: Buy a $500K property with $100K cash and a $400K loan.
If and when the property appreciates to $600K the following year, what happens?
• Cash Option: Return on equity = 20% ($100K increase on a $500K investment).
• Leverage Option: Return on equity = 100% ($100K increase on a $100K investment).
By using leverage, not only do you outlay less cash but you also get a much higher (5x to be exact) return on equity.
Using Home Equity To Buy Real Estate: How To Obtain Leverage
So, by now you’re probably starting to think that this whole leverage business makes a lot of sense but — the question of the hour — how do you make it work for you? Well, when you own a property and you have equity built into your home, you’re allowed to leverage home equity (i.e.borrow that home equity, meaning that mortgage providers will let you refinance or re-draw 80% of the market value of your home) for a nominal, low-interest rate. For example, if your house is worth $500K, a lender will let you borrow $400K (minus any current mortgage amount outstanding).
Using a Home Equity Line of Credit (HELOC) as Leverage
As mentioned above, it’s easy to obtain leverage if you’ve amassed equity in your home or a property that you already own. You simply need to approach your bank for a home equity line of credit, also known as a HELOC loan. You can then use this HELOC loan leveraging your home equity to buy another home in Canada or to buy a rental property. You can use equity to buy another house.
Let’s take the $400K property from above and let’s say you still owe $200K on your mortgage. In this scenario, you can still borrow $200K (from 400K – 200K), at roughly 3% or $6K each year, which over five years would amount to $30K.
Are you still with us? Good.
Using A HELOC to Buy Investment Property
At this point, you can invest that $200K into a rental property, which will accumulate its own equity over time to more than make up for the $30K extra you will need to pay in interest on the initial loan. And, as a cherry on top, the Canada Revenue Agency (CRA) allows you to deduct the interest portion of your investment property mortgage from your taxes, so it’s a win-win.
When it comes to this setup, the more properties you add the more complicated the math becomes, but you get the idea: more leverage leads to more equity leads to more money in the long run! By using leverage, you increase your ability to purchase high-value investment properties which subsequently increases your net gain as property values appreciate. You can keep using equity to buy another home and continue this cycle.
Home Equity Loan vs Home Equity Line of Credit (HELOC)
The difference between a home equity loan and a home equity line of credit (HELOC) might sound complicated but it’s actually quite simple. A loan is a fixed amount of money in one lump sum paid upfront. You’ll start paying interest on the loan the moment you take it out. The reason why I always suggest use a home equity line of credit (HELOC) instead is that you only pay interest on the funds you use as you use them. This can make a big difference when it comes to purchasing a pre-construction condo with borrowed funds. Unlike re-sale where you put down a 20% down payment upfront, pre-construction is paid in installments – typically 15% in three installments over the first year with the final 5% paid approximately 4 years later upon completion.
Now that we’ve broken down how you can benefit when you borrow money and leverage a property instead of paying cash down, download our Guide To Investing In Pre-Construction Real Estate. Let us show you how coupling our leveraging strategy with our Platinum Pre-Construction Investments will maximize your return on investment.
Finding the Best Condo Investment in Toronto
Traditionally over the last 15 years, the majority of people who have invested in pre-construction Toronto condos have made a lot of money doing so. The ability to leverage a small amount of money over a longer period of time has proven to be a successful investment strategy and we’ve been conditioned to believe that this is the best way to make a great return. But the real estate market is exactly that — a market. And the market is changing every day.
If you are interested in using equity to buy another home in Canada, read our latest post: Finding The Best Condo Investment In Toronto.
Disclaimer: It’s important to note this is a financing tool to get ahead faster. This is not a suggestion to take out all of the available debt to you and spend it on a whim. You must budget correctly otherwise you can get yourself into trouble.