One of the great advantages of home ownership is that you can leverage the equity in your home to help you earn extra income in the real estate market.
If you’re looking to buy a second property, money in the form of a home equity loan can fund a down payment -- or help you buy outright at a short sale auction.
A second property can earn you money in three ways:
Buying a Property to Flip
Flipping houses is not for the faint of heart; it comes with many risks. Before you commit equity in your home or any other money to such an adventure, be sure you’re well versed in the following areas:
The market: If you’re buying in a hot market, your margin for profit is very narrow. Be sure you know what’s going on in the area. Is the market just catching fire, or is all that remains the dying embers of a once-hot real estate boom? Look for comparable home sales in the area.
Condition of the property: If you’re buying low to sell high, repairs are, no doubt, going to be part of your financing plan. Be sure you know the full condition of the property. If it’s a sale where inspections aren’t allowed, build extra funds into your budget.
Patience: You’re going to have to learn to strike a balance between wanting to cash out of the project as soon as possible and waiting for the right price. Of course, the longer you wait, the more carrying costs you’ll be paying. A savvy flipper knows how to play this waiting game. Are you ready for that kind of stress?
Buying a Property to Rent Out
If you’re ready to be a landlord, taking on a second property as a means of generating rental income can be a wise use of your current home’s equity. There is more to being a landlord than just cashing checks, however.
First, you have to find a property in an area that’s going to generate enough rental income to not only cover your mortgage expenses and property tax but one that will also give you some profit as well.
Second, you’ll have to have a repair budget. Things break even when you are blessed with ideal tenants. A major expense can wipe out your profits for some time. There are management companies who can deal with upkeep and tenant complaints, but their fees will cut into your income. If you’re not handy yourself or don’t have the time to look after the property properly, be sure you have a reliable, competent handyman on call.
Some people are not cut out to be landlords. Consider its pros and cons before committing to becoming one yourself.
Buying a Vacation Property
While a typical rental property has tenants in it the year ‘round – ideally – a second type of rental property can generate some great income at specific times of the year. Owning a property in a tourist destination can be a real cash cow if everything goes right – and you can even use it yourself for your own vacation needs.
If the property is not nearby, though, you’ll almost certainly want to hire a management company to mind it for you. This will relieve you of the stress of booking, maintaining and cleaning it between guests, but it will cut into your profits.
All of the caveats that come with flipping also apply: know the market and the desirability of your location.
Real Estate for Retirement
Having a real estate portfolio is a great way to help fund your retirement – especially if you use your existing home to help finance the effort. Since some people are looking to downsize when they hit retirement age, having multiple properties to turn into cash is a great way to enhance your income in your golden years.
The Home Equity Loan Advantage
Remember that home equity loans can be tax deductible1 (please consult your tax advisor regarding deductibility of interest) and they usually have lower interest rates than any other type of loan. These factors can be a real boost to your second property endeavor.
But also, remember that there is a risk inherent in all home equity loans and that is if you should default, you could not only lose your second property but the home you’re living in as well. Always approach investments of this sort with a good amount of caution. Talk to people who’ve done it as well as a professional financial consultant.
Once you’ve informed yourself properly, you’ll be ready to make a clear-headed decision to proceed (or not). And if you’ve given yourself the green light, then you’ll find that a home equity loan can be your best tool for the operation.
1. Home Equity: APR is Annual Percentage Rate. Loans Subject to approval. Combined Loan-to-Value (CLTV) cannot exceed 80% of your home’s value. Additional terms, conditions, and restrictions may apply. Amplify Membership and Property Insurance required.
HELOC: The home equity line of credit Annual Percentage Rate (APR) is variable and is based on the highest Prime Rate published each month-end in The Wall Street Journal Money Rates Table (the "Index"), plus a margin. The current Index is 3.50%. Maximum APR is 17.90%. This Account has a Draw Period of 10 years, after which you will be required to repay any amounts within a 10-year term. Interest on your HELOC may be tax-deductible – please consult your tax advisor for details. Property Insurance, including flood insurance as needed, is required. Loans Subject to approval. Additional terms, conditions, and restrictions may apply. Amplify Membership required. Consult the CFPB's Home Equity Line of Credit booklet as well as the Early HELOC Disclosure for more information.
Under Texas law, the maximum you can borrow with a HELOC is 50% of the fair market value of your home, as long as the combined loan-to-value does not exceed 80% in cases where there is an existing first lien mortgage on the home. A minimum draw amount of $4000 is required for each advance after the initial $10,000 advance at origination.