Leveraging equity to scale your portfolio
As property managers and realtors, we constantly educate our clients on the value of home ownership. Whether it be your primary residence or a rental property(s), the investment you make typically will yield financial gains over and over again, if managed properly.
Home equity is simply how much of your property you own, specifically how much you’ve paid for versus how much mortgage is left to pay off. If your property is worth $400,000, and you have $350,000 left on your mortgage, your home equity is $50,000.
When you borrow against your home equity, your property becomes collateral. In return, you get lower interest rates.
Leveraging this money allows you to create and build wealth faster than if you were to just do it by saving up.
There are two ways lenders will allow you to borrow using your house as collateral:
- A Home Equity Line of Credit (HELOC)
A HELOC is much like a credit card that allows you to withdraw any amount within the credit limit and period of validity. It allows you a lot of flexibility because paying off the principal frees up your available credit.
- Fixed Term Home Equity Loan
In a home equity loan, a lump sum is released to the borrower. Payments are amortized over a set period of time.
According to the Financial Consumer Agency of Canada, HELOCs are second only to mortgages as the largest contributor to the growth of household debt, thanks to their accessibility and flexibility. However, let’s look at the facts:
- 49% of borrowers spent their debt on renovations,
- 22% on debt consolidation,
- 19% on the purchase of a vehicle,
- 19% on daily expenses, and 13% on vacations.
- Only 11% used their HELOCs to acquire residential properties and make financial investments.
36% of HELOC borrowers aged 25-34 used their loans to pay off other debts. Initially, this seems to make sense, as it is essentially replacing those debts with one that has lower interest rates. However, is this the most efficient use of a loan?
Low interest rates o have been enticing, but to avoid the pitfalls of debt build-up, borrowers need to see loans as assets to grow their wealth rather than fund their lifestyles.
But where do you put that money, and how do you manage the risks? Here are some ideas.
- Investment property. Some will opt to make another real estate investment using their existing homes as leverage. A residential, commercial, or retail property can be rented out and turned into self-liquidating assets.
- Renovations. Renovations, which account for the lion’s share of loan spending, may actually be a wise investment if the homeowner plans to sell the property at some point. Depending on the location and the real estate trends there, renovations can increase the value of the property.
- Education. When making the decision to pursue further studies, you must ask yourself whether or not education is a good investment that can realistically benefit you financially in the long run. One thing to note is that education is something that, unlike a house, cannot be foreclosed or taken away from you, but that is not to say that a diploma will automatically increase your wealth either.
- Business. Many entrepreneurs make the mistake of putting their business expenditures on credit cards. The high-interest rates can be fatal to an enterprise; when the company hits a downturn, which is common for any business, those debts can balloon faster than people realize. Borrowing against one’s house is a cheaper way to start a business or fund its expansion.
- Stock market. Purchasing stocks are known to be high risk, but a quote from Investopedia is worth mentioning: “There are no perfect definitions or measurements of risk.” Market volatility is definitely a concern, but some stocks carry more risk than others. This will depend on many factors like industry sector, economic trends, and the company’s history and profile. When investing in stocks, the first thing one must take into consideration is the expected returns versus the cost of acquiring the debt used to pay for them.
Risk tolerance is also something to give thought to. While it may yield high returns, can also prove financially disastrous. Diversification is a great way to spread out these risks over multiple investments.
There isn’t a single type of investment that is right for everybody. It will depend on your personal circumstances, existing assets, and tolerance for risk. The bottom line is that one should treat debt as a way to increase one’s personal wealth, and not as a means to instant gratification.
Before engaging in this strategy, you should speak with a Mortgage professional about your individual situation. However, for those of you looking to scale your portfolio and scale it quickly, it could be a great option for you.
Welcome Home has many relationships with a number of lenders and we’d be happy to refer you to a mortgage professional.