So, you want to buy an investment property, but you don’t have the liquid cash to make a great down payment. What do you do? One option is to use the equity of an existing property to fund the down payment. While some believe this is a huge risk, others believe it’s a necessary risk considering the potential of the new property. Here are some things to consider when deciding about whether to borrow against equity to buy another home.
Basics of Equity
First, before making a decision or weighing the pros and cons, you should know the basics of equity and equity loans. Equity is the difference between the current market value of your existing property and the amount you still must pay on that property. So, if your property was worth $500,000 and you still have $300,000 left to pay, you would subtract that quantity to get your equity, which is $200,000.
To calculate your usable equity, however, which is the amount you would actually borrow, you would factor 80% of your property’s market value, in this case $400,000, minus what you currently owe, leaving $100,000 in our example, and multiply by four. In this case, you would, therefore, be able to borrow $400,000 to use on the down payment for an investment property.
Now, this procedure is common and has some favor to it. Some people argue that it’s a worthy risk, especially if the investments from the new property end up making up the new loan debt you accumulated. In addition, they know that the bank would not allow anyone to get the full useable equity and gain even more debt. Equity loans, when controlled and guided by financial experts and sound judgment, can be the means to a worthy end.
On the other hand, some argue that this is a reckless move that can place people in debt. Equity is a useful resource that can serve as additional funding for home improvement, maintenance, repair, or even job loss or medical emergency. By spending it, not only are you giving up emergency funding, but you will also take on additional debt from the equity loan. Not to mention that spending money on an investment property is a risk. If your new investment doesn’t pan out, you can lose both of your properties.
Make the Right Decision
Ultimately, the decision falls on you. Do the market research and see how much your new property is worth. Don’t invest on something you can’t afford. Also, use a professional appraiser as a financial advisor to make an informed decision on your investments.