When looking to become a property investor, your first major obstacle is often how to meet the lender’s requirements for an investment property loan. As a rule, it is easier to get a loan to buy your own home than to get a loan to buy an investment property.
Blanket Homes explains that lenders view investment property loans as a considerable risk. Borrowers are more likely to default on an investment mortgage than their home mortgage since defaulting on their home mortgage means the investor will become homeless.
To protect themselves, lenders have stiff conditions for investment property loans. That ensures that only the most qualified individuals can access these loans. But it also has the unintended consequence of excluding some honest and hardworking citizens.
If you have a strong desire to become a property investor but have not been able to meet the conditions for an investment property loan, should you give up on your dream? If you own your own home, the good news is you may already have a way to solve your problems.
How?
You can raise the money to buy a rental property by leveraging the equity in your existing home. Is this possible? Yes, it is, and this post explains the steps to leverage your home equity to buy a rental property and the prerequisites.
What is home equity?
Home equity is the percentage of your home’s value that belongs to you. If you sold your home today, some of the money you realized would go to your bank to pay off the balance on your mortgage, and the rest would come to you. The part of the money that comes to you is your home equity.
In the simplest terms, your home equity is the market value of your home, less the money you still owe on the property. Your home equity grows in two ways: as you pay off the mortgage on the house and as the value of your home increases, either because of market forces or through home improvements.
Calculating your home equity
Calculating your home equity is relatively easy; you need to know the current market value of your home and deduct the money you still owe the bank from that amount. What is left is your home equity. That is, the home’s current value minus the amount owed on the home equals the home equity.
Here is an example of that:
- The current value of the home = $900,000
- The total amount still owed on the home = is $560,000
Home equity = $900,000 – $560,000 = $340,000
Home equity = $340,000
In this example, $340,000 is the total amount available to the homeowner as their home equity. But, the bank will typically not let you draw 100% of the available money. In most cases, the most you can take out of your home equity is 80%, which is $272,000 in the example above.
Using your home equity to buy a rental property
Before your bank agrees to let you use your home equity as a down payment for a rental property, they will have to look at your finances. Banks want to see a demonstrable ability to service two mortgages: your primary mortgage and the mortgage on the rental.
To make getting the lender’s agreement easier, you should work to improve your debt-to-income ratio (DTI) beforehand. That is how much of your monthly income is left after you have settled all your debt obligations. You also want to have some money kept aside as cash reserves.
When using your home equity to buy a rental property, there are ways you can access the money:
A. Home Equity Loan
This pays a lump sum from your home equity into your bank account. You may use this money to make the down payment on the rental property and pay the mortgage closing costs. To repay the loan, you make monthly payments with a fixed interest rate (usually).
B. HELOC (Home Equity Line of Credit):
This extends a line of credit to you from your home equity. That is similar to a credit card; you can withdraw from the account whenever you need money and repay the drawn amount within a set period. You only pay interest on the amount you draw. A HELOC is great for flipping houses.
Understanding the risks of leveraging your home equity
Like every financial decision, using your home equity to finance a rental property has risks. Before you use this method:
- Understand that your home’s value and your overall equity can fall if the market changes
- If you fail to make the mortgage payments on the properties, you could lose your home
Even though leveraging your home equity to get started as a property investor is a well-tested strategy, you still want to talk to an expert before you use this option.
We are pledged to the letter and spirit of U.S. policy for the achievement of equal housing opportunity throughout the Nation. See Equal Housing Opportunity Statement for more information.
