Is Tapping Home Equity a Good Way to Get Into Property Investing?

Is Tapping Home Equity a
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Property has historically been one of the most profitable investments around. Real estate almost always appreciates over time, and investing in property by way of rental strategy can produce residual income year after year. But how does a first-time investor get into property? Is tapping into existing home equity a smart way to do it?

The home equity question deserves an answer simply because so many real estate gurus recommend it as an option. Tapping into home equity can work, but doing so is a risky proposition. New investors need to think long and hard before risking their homes to get into the property market.

How Equity Can Be Leveraged

For the remainder of this post, assume we are discussing a first-time investor looking to purchase a residential rental. This sort of scenario represents the most basic form of property investing. With that in mind, there are multiple ways to leverage existing home equity to get into that first rental. An investor basically has four options:

  1. A home equity loan.
  2. A home equity line of credit.
  3. Refinancing the existing home.
  4. Taking out a second mortgage.

Regardless of the particular method, leveraging home equity essentially means turning that equity into cash that can be used as a down payment on an investment property. The more equity an investor needs to work with, the higher his down payment can be.

The hardest part of tapping into home equity is convincing the lender that your plans are not too risky to fund. That’s easier said than done. Banks and credit unions are generally averse to real estate investing anyway. Asking them to loan against your house for something that already makes them nervous is a challenge.

You Could Lose Both

Moving on to the risk part of the equation, tapping into home equity more or less equates to pushing the envelope. Think about it. Leveraging equity means putting an additional financial burden on your home in order to fund a rental property you are hoping will generate consistent income. If everything works out as planned, both you and your lender will win. But what if things don’t work out? You could lose both your primary residence and the rental property.

Imagine your first tenant sticks around for a full year but then doesn’t renew. You struggle to find a replacement, leaving you without rental income for six months. Now you are behind on both the rental property mortgage and your home equity loan. Both properties are now at risk.

There Are Other Ways to Fund

The good news for first time investors is that there are other ways to fund that initial purchase. One option would be hard money. Actium Partners, a hard money firm based in Salt Lake City, UT, says that some hard money lenders specialize in residential rentals. Actium does not. Most of their loans go to commercial real estate investors.

Regardless, setting up an LLC prior to obtaining that first property gives a first-time investor a bit more leverage to obtain a hard money loan. The LLC becomes the borrower rather than the investor himself. The loan then becomes a business loan rather than a consumer product.

There are still other options that space will not allow this post to cover. Needless to say that tapping into home equity isn’t the only way to break into the property market. It is one way, but it’s also risky. Leveraging home equity puts an investor’s primary residence at risk for the foreseeable future. Is that a chance you would take?

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