Real estate investing can be lucrative when done correctly. Now, rising demand is driving up home prices. With rising home prices, however, real estate investors are finding it increasingly difficult to add to their portfolio.
Professional real estate investors are competing with families looking for single-family homes that are already in short supply across the United States. Many property investors are finding that they need to look for financing to grow their portfolios. This means taking on debt for the most part. Generally, investors who rely on their own assets and credit try one of two financing tactics: an equity lending product or a new mortgage.
Here, we explore each option, so you can better determine the best option for you.
Should You Rely on Your Equity?
When it comes to equity products, there are two main types: a home equity line of credit (HELOC) and a home equity loan. With any equity product, you’ll only be able to borrow against the equity in your home, which is the difference between what you owe on it and what it’s worth. For example, if you own a house that has been appraised at $400,000, and you still owe $200,000, then you have $200,000 of equity remaining. You can only borrow up to 80% of the value of the home.
If you choose to take out a home equity loan, you’ll receive all the proceeds immediately, with a repayment schedule beginning the next month. It works much like an installment loan in a few ways; for instance, repayment occurs over a set monthly schedule.
If you decide to use a line of credit instead, you won’t be able to use your full equity all at once. Home equity lines of credit come with a draw period which is when you’re allowed to withdraw funds multiple times. Once the HELOC goes into repayment, no further withdrawals are allowed. The post-draw repayment period usually lasts 5 to 10 years.
If you think you’ll need to use the equity funds more than once or would like more flexibility, a line of credit may be the better option. Investors who purchase a home that needs repairs, for instance, can benefit from a HELOC with the room to not only expand their real estate investment portfolio but also handle the additional expenses.
There are downsides to consider. For starters, there are credit requirements for taking out a home equity product. This could make it hard to borrow against your equity, or it could leave you with unfavorable terms. If you’re unable to make the monthly payments, you could go into foreclosure on the property securing the loan. Additionally, your credit could suffer as a result, making it difficult for you to get further credit offers.
Should You Take Out a Second Mortgage?
An alternative to relying on equity is taking out a new mortgage secured by the investment property itself. You can get another mortgage from banks, credit unions, and lenders that specialize in real estate financing.
You can usually close a second mortgage within 45 days from application if you already have a property in mind. Common characteristics of a mortgage include lower interest rates than an auto or personal loan. Mortgages have longer terms such as traditional 30-year and 15-year repayment terms.
The biggest advantage of using a second mortgage instead of an equity product is that it protects your residence from risk in case you cannot make the payment. You won’t foreclose on your current home if you cannot pay off the second investment property.
The obvious disadvantage is that a mortgage is a long-term loan. It’s a much longer commitment compared to an equity solution. You could find yourself locked in decades of repayment alongside the challenges of owning and managing an additional property.
The Bottom Line
When weighing your options, understand your own situation and what your goals are. Real estate investors who are also supporting a family might want to take the safer route of using a second mortgage for a new property. In that way, their primary residence is protected. Those who can afford a little more risk and have more equity as well as stronger finances might want to look at the home equity option.
Whatever you decide, be sure to talk to several lenders, advisors, and other property managers about your options. Learn the details of each product before you sign on the dotted line.
This article has been contributed by Andrew Rombach, Content Associate at LendEDU, a consumer education website and online financial product marketplace.