HOW TO LEVERAGE MONEY IN REAL ESTATE
We all dream about it, that idea of 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? What if there was a simple formula to make investing in your future doable today? Investing does not need to be such a daunting task. Stick with us and we’ll show you how more debt = more money.
But this complicated head-spinner needs a bit of explaining. Today we’ll show you how you can leverage home equity to generate 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. Watch the video below or keep reading.
Good Versus Bad Debt
In general, good debt increases your net worth and/or helps you to generate value (ie. taking out a mortgage, borrowing student loans or accessing a line of credit to consolidate debt) while bad debt typically uses borrowed money (ie. credit cards, payday loans, etc.) to purchase goods or services that have no lasting value, like that sexy car in your driveway. Don’t get us wrong, we love toys as much as the next person, but from an investment standpoint, they aren’t going to bolster your financial portfolio.
What is Equity?
The longer you hold a property, the more equity it will earn. For example, let’s say you had bought your current home for $400K. Since buying it you’ve managed to pay $150,000 towards your mortgage and it’s appreciated in value by $200K over the last few years. The fair market value (FMV) of your home will be $600K. The equity 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 borrow 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 your home equity 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 an outright cash vs. leverage scenario:
• Cash Option: Buy a $500K property using all cash.
• Leverage Option: Buy a $500K property with $100K cash and $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.
How Do I Obtain Leverage?
So, by now you’re probably starting to think that this whole leverage business makes a lot of sense but — 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 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.
Let’s take the $500k 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.
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 = more equity = 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.
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.
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.