How to use your Home Equity to make money

Your home equity is how much you own of your house. The rest really belongs to your bank. If you own a home that’s worth $500,000, with a mortgage of $300,000, then you have $200,000 in equity.

What can you do with that equity? How can you use that money to your benefit? Buy a nice car? Go on a wild vacation? 

You should ask yourself why you borrowed money to buy a house in the first place. Your mortgage provides you with a place to live in return, and a place to sock away money in the form of paying down your loan. Your mortgage gives you back an asset, and potentially makes money for you in terms of appreciation. Your home equity should also make money for you.

What’s the difference?

There are 2 ways to make use of your home equity-a home equity loan and home equity line of credit (HELOC). Both are fairly easy to qualify for because the bank is tying your house into it. They know you’ll want to pay up. They are both easy ways to get large sums of money to use however you like.

A home equity loan is just like it says. It’s a loan. You borrow a certain amount of money, and you have a certain amount of years to pay it off, just like your primary mortgage.

A HELOC is like a credit card. The bank gives you a certain credit limit, and you’ll have typically 10 years to use that credit. You pay interest only on the amount used, just like a credit card.

Either way, it’s like having a really nice and generous loan shark by your side. Just make sure you’re making more money with the loan than what he’s charging you. And always have a contingency plan to pay him back. Always be flexible and adaptable. You wouldn’t want him coming for your house.

The spread

If you are borrowing money at 5% interest, you should ideally be making a good amount of interest off of it. Let’s say you use that money to make 10%. Would that make it a good investment? You take a risk and borrow at 5%, but make 10%. You net 5%. Is the spread worth the risk? Is the 5% reward worth the risk? Or, should you try to make 15% and build yourself a larger margin of safety?

It’s up to you to decide what is an acceptable ratio of risk vs. reward. Everybody has a different level of risk tolerance. But, generally, the more prepared you are financially, the more risk you can afford to take, and the higher reward.

If you use borrowed money on things which don’t make you any money, then you are simply taking a risk without the possibility of any future reward.

The investment

I’m sure there are numerous ways people make money on borrowed money. I’m no expert. I’m sure there are much more sophisticated ways of using that money to make money. I’m not there, yet. But, what I have done is used our home equity to buy real estate.

Wow! You must have a lot of equity in your house! Yes, but it’s still not enough to buy a property outright in NYC. What we did was used a small portion of our HELOC as partial down-payment for our investment properties.

Example: We used $100,000 of HELOC, along with our own cash, as down payment for a small multi-family house. It’s an amount that we felt comfortable with. We always built in contingency plans when we did deals like that.

First off, we would’ve never borrowed the money if we couldn’t cover it ourselves if things didn’t go well. That’s why living on 1 income all this time has worked out really well for us. We would aggressively pay down the HELOC with our own savings every month.

We also knew fairly well that my wife was due a bonus in the near future, which would pay off a large portion of the loan.

Finally, the rental numbers worked. It’s all about the numbers. We wouldn’t have bought unless it cash-flowed a decent enough amount to pay off the remainder of the HELOC in a short time.

Between her bonus, extra money from our salaries, and the cash-flow, we paid off that HELOC in about 6 months. At 4% interest, we paid a total of about $2400 for the bank’s help (in addition to the regular mortgage we took out) in buying that particular investment property.

Had we not used the HELOC, we wouldn’t have had enough money for the down payment, and would’ve missed a good deal. The HELOC really enabled us to buy that property at the time.

After paying off the HELOC, we were left with just the regular mortgage to pay every month, which increased our cash-flow and gave us our targeted 10% cash-on-cash return (how much money our own money was making per year, after all expenses).

What not to do

Don’t think of your home equity as free money. You’re still borrowing money. You still have to pay it all back, and with interest. You still have to make sure that at the end of the day you yourself can cover the costs. After all, you wouldn’t buy something on a credit card that you couldn’t pay off the next month. You’re not banking on somebody else to pay off your credit card bill for you. And, it’s worse with the home equity because the bank has your house tied to it. You’d better pay if you want to continue having that roof over your head.

Don’t do what some first-time investors do, which is to use their home equity, in addition to taking out a regular mortgage, to buy houses that ultimately do not cash flow. They are then stuck with houses that bleed cash every month, meaning they have to put in their own money just to cover expenses. They are essentially buying investment properties using 100% borrowed money, while not making a penny in cash flow. That kind of first-time investor quickly becomes a one-time investor, and potentially a renter.

Finally, need I say it? Don’t use home equity to buy things that don’t make money, because all you’re really doing is using it like a really big credit card that’ll get you in really big trouble. (Yes, yes, there are exceptions to everything. But, they are few. For example, using your equity to improve your home, to a certain extent, can not only be profitable, but will make living there more comfortable.) And, it’s worse than a credit card because you’re scheduled to make smaller payments over a longer period of time, which means you ultimately end up paying a lot more money for whatever toy you buy.

Conclusion

You can use home equity to buy anything you want. You can also use it to make money. I’ve just given you one example of how it can be done. But, like any form of borrowed money, you have to make sure that you make more money than what the lender is charging you. And, you make damn sure you can pay it all back. If all your finances are in order, you can use home equity to help you buy an investment property, which generates more money for you to buy another investment property, which…