– Lead Planet –
One of the best reasons to own a home is the opportunity to build equity over time. You build equity in your home in three ways:
- By paying your mortgage every month, which reduces the principal balance
- By putting money down when you bought the home – anywhere from 3.5% to 20% down payments are common
- By the home appreciating in value over time
After you have made at least six payments on your home loan, you can if you like, pull money out when cash out refinancing. Most lenders will allow you to pull 80-90% of your total equity out when you refinance. If you have a home worth $200,000 and the balance on the loan is $100,000, you have $100k of equity. So, you could pull up to $80,000 or $90,000 out of your home. If you have earned equity in your home, then refinancing with a cash out loan may yield quick access to tax deductible money.
The question is: What is the best use of that money?
In the past, many homeowners used their equity to buy cars, go on vacations, pay for college and do home improvements. Some of those uses of your home’s equity are smart, and some are not. Generally, financial experts argue that you should only use your home’s equity for some type of investment where you are highly likely to get a higher rate of return than you are paying in interest on the loan. One of the best ways to do this is through the wise investing of your equity into real estate investments.
Different Real Estate Investing Options
Investing in real estate can be a very good way to grow your nest egg over time, if you do it wisely. There are several ways that you can invest your cash out equity into real estate, depending upon your interests, goals and risk tolerance. Let’s review each cash back refinance option in detail:
#1 Buy and Hold Rental Properties
Probably the most popular way to make money in real estate investing is to buy a single family home or apartment building, and hold it long term as a rental property. You can use your equity as either a down payment on a buy and hold investment property, or even buy it with all cash.
After you have closed on the property, you then need to repair the property well enough that it can pass inspection and be rented out for a fair market value rental price.
There are several things that you should keep in mind when you are buying and holding rental properties. You want to be certain that your property is going to be a good long term investment:
- Buy in an area where home values are appreciating and the crime rate is reasonable. You do not want to buy in a war zone where you cannot find good renters.
- Buy in an area that is not too expensive. Some risk averse real estate investors end up buying properties in A-quality neighborhoods because they want to minimize chances of problems with renters. But if you buy in too expensive of an area, you won’t have any cash flow.
- Don’t over rehab the property. A common mistake for an amateur investor is to spend too much money doing the rehab of the home. This can kill your cash flow in the deal.
- Pay as much below market value as you can. Your profit or loss on a property is often determined by the price you pay for the property.
#2 Flip Properties
For people who have limited cash, another major option to build income with equity from their home is to flip houses. The way this works is to work with a good real estate agent who knows investment properties well in your area.
He or she can help you find a property that is under market value, and then you hire a contracting company to rehab the property. You then flip the property to another investor or a home buyer and make a profit.
It sounds simple, but there are many things that can go wrong. Keep these tips in mind:
- Don’t overpay on the property. If you over pay, you will not make any money on the flip.
- Don’t overdo the home remodeling efforts. If you spend too much on the rehab, you may make nothing on the flip, or worse, lose money.
- Finding under market value homes can be hard. Locating the right properties in decent neighborhoods can be challenging, and there is a lot of competition.
- You can always buy cheap properties in bad neighborhoods, but if the neighborhood is crime infested, you will have trouble finding a good buyer.
Whether you decide to buy and hold or flip rental properties, you would always be strongly advised to partner with an experienced investor and real estate agent. Real estate investing can be profitable, but there are many ways to go astray and lose money.
The Bottom Line
We are generally big fans of investing in real estate with equity from our personal residences. However, you must be very careful that you are investing the money into properties that are going to generate profits. Do plenty of research and be sure that you are investing your money wisely. Otherwise, you will end up owing hundreds of dollars on your personal residence and this could cause you to fall into foreclosure eventually.