(Updated January 2015)
Say the words "home equity loan" out loud, and most people think "another monthly payment." But home equity can also equal megabucks if used as an investment tool. It's true: The equity from your home can be the working capital you need to initiate a slew of investment options.
Do you ever wonder where wealthy people got their start? Chances are that many used a small amount of capital to begin building wealth, one investment at a time. That sounds easy, but where do you find the capital to get the investment rolling?
The answer could be simple: your home equity. Whether it's a home equity loan, home equity line of credit (HELOC) or even a cash-out refinance, your property can help you start your own financial empire.
Using property to buy property
One popular strategy is to borrow against your home equity to make a down payment on another property. Being able to make a down payment of 20-30 percent will make it easier to qualify for a loan to buy an investment property and will help you get a lower interest rate besides.
Another possibility, if you have enough home equity to work with, would be to use it to finance the entire purchase of an investment property. This offers several advantages. For starters, it would eliminate the need for an appraisal or to otherwise qualify the investment property for a loan. That can be if you're buying a unique property or one that needs significant renovations that might discourage a lender.
Using equity to finance an investment property purchase might also enable you to get a lower interest rate than you could on a loan secured by the property itself. That's particularly true if you use a cash-out refinance, since the rates for refinancing your own residence are considerably lower than for buying an investment property.
After you've made the purchase, you have several options. First, you could fix up the property and sell it for a higher price, a tactic known as flipping. The profit you make from that investment could then be used to purchase more properties.
In this event, you'd want to borrow enough to cover not only the down payment, but the cost of fixing up the property as well. In that situation, a HELOC can be useful because it allows you to borrow money as needed, rather than borrowing the whole amount up front and paying interest on the whole thing from the start.
Second, you could hold onto the property and rent it out. The rent would cover your mortgage payments, allowing you to reap the rewards of a tax deduction (on the loan interest) and any appreciation that the property will have over time.
You can even buy a vacation property for your own use and rent it out part of the time as an investment. As long as you use it for less than two weeks a year, or 10 percent of the time it's in use, whichever is less, you can still treat it as an investment property. If you use it more than that, you can still take deductions on the pro-rated portion of your expenses for the time it's used as a rental.
Make your way to the market
Another wealth-generating tactic is to use your home equity to purchase stocks, bonds, or other investments. Depending on the home equity loan rates, this can prove to be lucrative, especially if your return on the investment proves to be significantly higher than the interest rate paid on the loan.
Again, you reap the tax deduction benefits of the home loan. However, you want to be sure this is going to be a fairly secure investment, such as buying stock in a company or industry you have full confidence will offer strong performance in the years ahead. Don't borrow against your home for mere speculation.
Rehab your habitat
Mortgages can also be used as home improvement loans to renovate your house or apartment. Build an addition, remodel your kitchen, upgrade your bathrooms-these are all methods for improving the value of your property.
If you plan to move to a more expensive house, this is an ideal way to make the transition affordable. It's also an effective strategy if you need or want a larger, more comfortable home but real estate prices in your area are prohibitive - it's often more affordable to fix up than to move up.
Use good judgment
Obviously, you want to proceed with caution any time you're using your home equity to back a loan for investment purposes. Remember, you're putting your home at risk here, and you could lose it if the investment doesn't pan out and the added debt burden means you're unable to make your mortgage payments.
The key here is not to borrow more than you can afford to lose, or to take on more debt than you can handle with your current income. Relying on an investment to pay off in order to make the higher payments required by your home equity borrowing is a good way to get into financial trouble.
Home equity has long been used as a popular debt management tool. But the astute investor can use a little of his property value to generate more than a little wealth.