So how do you take out equity in your home or investment property? And, should you take equity out of your home or investment property? It depends upon a few things, let's take a look and learn the best way to take equity out and why you might want to take out equity of your home or rental property.
Basically, a home equity line of credit or loan is using your home as collateral and paying it back over time at a set interest rate. And sometimes the home equity line of credit is called simply a HELCO.
First off, in a HELCO, if you're taking out equity to pay off a debt that has a high interest rate, that's probably smart. If you're taking out equity to make some improvements on your home or rental property, which will increase the value of the property, that's smart, too. But if you're taking out equity of our home or property, essentially using your home or income property as a bank to borrow money, to buy a flashy new car you don't need, that's probably not smart. When you take out equity of your property, use that money wisely.
Equity is basically the amount of a property that you own. For example, if your house costs $200,000, and you have already paid $100,000 of your mortgage, then your equity—or how much you own—is half the initial value, or 50%. So you have $100,000 in equity in your property.
Having a lot of home equity is very useful, not only because you can lay claim to an ever increasing portion of your home, but for other reasons that are related and impacted by how much of your home you own.
Say you have your eye on another piece of property that costs $500,000. And let’s say you have $150,000 of equity earned in your current home that has a value of $300,000. This means that half of that house is yours, according to the $150,000 that you’ve already invested into it, and you can use this equity towards capital for another investment, which in this case is that other property you’ve been looking to purchase. Taking out equity on your current home will allow you to secure a loan or make a down payment on that other potential rental property.
An additional benefit is that taking out a home equity loan allows the homeowner to remain in his current home, which he may otherwise have to sell in order to cash in on the equity he’s paid down so far.
But there’s a catch. The loan you acquire from the lender will be tied into your current house because you’re offering what you’ve already paid as collateral, which means that the lender can take your house away if you fail to meet the terms of your loan. Also, if you sell a property, you’ll have to pay taxes on the money you’ve made with appreciation, so it’s wise to consider a few things:
- What you will have to pay in taxes.
- Look into doing a 1031 exchange.
- Refinancing and pulling out some money, but not too much.
An equity loan or line of credit has other benefits as well, other than allowing you to take out a loan based on how much of your home you own.
- Your loan repayment terms can be extremely flexible because the lender knows that he/she can acquire your house as collateral if you default.
- You can enjoy lower monthly payments and lower interest rates. This is partly due to the amount of your house used as collateral, but probably more so because your payments on an equity line are based on interest and not on the amount of the loan.
- Most home equity loans are available with no closing costs and involve very few fees.
People take out equity loans for a variety of reasons, many of which are not even associated with real estate investing. So listed below are some of the possibilities that equity loans may allow you to pursue.
- Unexpected Expenses - Because home equity loans have some of the lowest interest rates, you can take advantage of this by paying for unexpected costs, such as hospital visits or car repairs.
- Home Improvements – You can make expensive renovations, such as replacing your existing roof or adding a garage to increase the value of your current home.
- Education – If you want to send your children to school, an equity loan will help you do so. Besides, with these low interest rates, who would want to take out a student loan?
- Debt Consolidation – By taking out an equity loan, you can consolidate your debt and ultimately gain financial solidarity. But remember to cut costs to sell assets that hold you back when you can and to reinvest your money back into your home equity if the possibility is there.
Because equity loans are based upon the equity of your current house, people take advantage of this type of loan if money is needed quickly, or if a great deal of budget flexibility is not available. This can be highly convenient, especially if you have invested a great deal of money into the house or have owned the home for a long period of time and built up equit.
TIP: You can receive a tax benefit with equity loans because the interest on the loan is deducted, which in effect forces the government to pick up part of the tab on the loan repayment.
According to Yahoo Real Estate, an individual is allowed to take out up to $100,000 from their principal residence in addition to the original debt used to buy the home, and deduct the interest charged before it is repaid. For more information on this, check out IRS Publication 936 Home Mortgage Interest Deduction.
However, it’s extremely important to invest your equity loan wisely. Remember, you have to pay back this loan, so make sure to invest your money into something that will allow you to not only generate a profit but to pay back your loan as well.
Therefore, it’s imperative that you weigh your expectations and risks realistically, taking into account your goals, plans, financial situation, and all other factors that relate directly to the loan.
In other words, be responsible. But whatever you invest in with the equity loan, make sure to consult a financial advisor beforehand. You want to protect yourself and your assets by making smart decisions and investments.