If you have owned your house for over 5 years, you likely have Equity that could be used to buy rental property.
That same equity, could be used again and again to build an entire portfolio of rental properties.
Each rental property can provide you with cash flow, and each property can provide you with its own equity that you can also invest in even more properties.
Think of each rental as an oil well, working 24 hours per day, trickling out money to you, and for as long as you own it.
This sounds great; but how does this work?
1st: What Is Equity
Equity is what a property is worth, above what is owed on it. If you have owned a property for 5 years, there are a few wealth building dynamics that have likely been hard working to make you rich, maybe without you even knowing.
You buy a property and 5 years later a few things have likely happened:
- Debt Paydown (like a savings account -only better).
You have been paying your mortgage each month (60 months in fact). And each month you have made your mortgage payment, you have likely paid both Interest and Principal. With the interest you have been paying to the bank for lending you the money (don’t get upset, you got a nice tax deduction for this); but the principal has been like paying back yourself. And that has likely become equity - 60 months of it!
- Inflation Has Devalued Your Debt:
Highly cyclical; but inflation tends to increase an average of 3.6% per year. So your debt (the money you still owe) has likely been decreasing in value. 3.6% multiplied by 5 years, equals 18%!
- Your Property Value Has Likely Increased (like, alot!)
There are exceptions; but it's generally accepted that property increases in value by the year. Though several factors affect this,the national average is that your property has increased in value an average of 5.7% per year. 5.7% multiplied by 5 years, equals 28%!
Let's start with an example property and with some real numbers:
- You bought a property for $100,000
- its now worth $128,500 (5.7% times 5 years)
- You have paid yourself $10,324.02 in principal by making your mortgage payments
That comes to $38,824 in equity.
Don’t forget the lender likely had you put a down payment when you bought it so you have another 3.5% to maybe 25% depending on how much you put down.
Also these factors are not taking in account any improvements (or detractions) you have made to the property. Nor are we taking into account speculation (is this an up and coming area, making property values increase, or has it been declining?).
Nor are we taking into accounts Up Markets or Down Markets. We are going to view Property Value, differently than Market Value. In other words, think of property value as a straight line that always tends to continue upward. We can say this is the actual, true value of the property. While market value goes up and down, depending on other people's interest and ability to purchase your property. If you purchased your property in a down market, you likely paid less than what we consider the property being worth. If you sell it, or refinance it, in an up market you will sell it or get to borrow more from the lender than it is actually worth.
So you may have other factors that will either get you more equity, or less equity than the above example.
Dead money is a term that some financial advisors use for money that is just sitting there, not earning its keep. We can pick on savings accounts, because they tend to be a very low return as an investment, especially considering they have to keep pace with inflation. Remember, if inflation is increasing at 3.6% yearly, your savings account interest will need to equal that just to keep you from actually losing money. But at least with a saving account your money has a job - just not a high enough paying one.
But Unused Equity doesn’t have a job, it just sits there, not even keeping pace with inflation. If it's not keeping pace with inflation then you are actually losing 3.6% of net worth yearly. Unused Equity is costly.
You work hard to earn money and it needs to be at least keeping itself from merely evaporating from your net worth. So using the equity might make sense.
When someone says they are a “cash buyer” they might not actually have cash, just easy access to it. They have “like cash” access. And so can you. Enter my favorite investment tool: The HELOC (Home Equity Line Of Credit).
A HELOC is typically an extremely low interest line of credit. It should be low interest, after all you are merely borrowing the money from yourself (your equity). In fact, a HELOC will probably be the lowest interest loan you can get and that’s one of the reasons this is such a great real estate investing tool.
The other reason is that this is a line of credit - so you won’t pay for this loan unless you use it. And you only pay on the amount that you actually use. If you only use a $1 of it, you now must pay back that $1, plus the interest. But no more. Helocs are incredible investing tools so we will talk about that in its very own article.
A Cash Out Refi is another way to access your equity. It's just not as attractive as a HELOC as it typically has a higher interest rate than a HELOC and you are given the entire lump sum amount of the loan and you need to pay it, and the interest, back, whether you use it or not. With a HELOC you can wait till a great deal; and waiting doesn’t cost you.
But since lenders only extend HELOCs on your primary home (where you live); you would need a Cash Out Refi to access the equity you have in a secondary property like a rental property or a vacation home - so these tend to be tools many of us also use.
If you are interested in accessing your equity to have it begin earning you money, you should talk to some lenders. They will help you determine how much equity you have and how much of it they will let you access.
After that all you need to do is choose a strategy on how to invest that equity. And we will get into those options in other podcasts here on Grow Real Estate Investing.
Meanwhile, I’m Joe White, Happy Investing!