So you’ve owned that condo in downtown Vancouver or out in scenic Victoria for about ten years now. You’ve made a lot of money renting it out, and you’ve been able to sock away double mortgage payments, and you’re just about done paying that mortgage. Then you get some bad financial news – your wife needs treatments for leukemia, or you’ve been laid off for the past six months and have burned through your savings. Nothing new is coming on the horizon, and you’re starting to wonder how you’re going to make ends meet. Meanwhile, this condo is sitting there, almost completely paid off. You may be wondering how to take equity out of rental property so that you can have some more liquidity while your job search continues.
First of all, the answer to the question “Can you take equity out of a rental property?” is “Yes.” For some people, it’s the best way to get access to cash when they need it. For other people, there are better ways to build some liquidity. Let’s take a look at the ins and outs of this decision and go over some scenarios in which it makes sense – and some others in which it might not.
How to take equity out of rental property
There are two major ways to take equity out of rental property: a home equity loan, or a home equity line of credit (HELOC). Both of these use the investment property as collateral, and you pay back what you borrow over time at a pre-set variable or fixed interest rate.
Have you been building up charges on your credit cards as you try to make ends meet? Then a HELOC to pay off those charges could make sense. Credit card balances often carry a much higher interest rate than a HELOC would. So you’re smart to save money.
What if you’re not in a bind financially, but you want to make some major improvements to your condo? If you don’t have the cash on hand, taking out a home equity loan (2nd / 3RD Mortgage) or HELOC to cover those expenses, and then to pay the loan back, can be less expensive than charging the cost of the renovations and then paying back those balances off your card.
It’s probably not smart to take out a home equity loan or HELOC because you’ve hit age 50 and want to buy that Corvette or other flashy sports car. Home equity is an investment that you have worked hard to build up over time. If you’re fairly close to paying off the mortgage on that rental property, then you’re about to have an infusion into your regular budget – which you could use to save toward that purchase.
A lot of our customers ask us just what “equity” means. Imagine your house as a giant aquarium. As you pay off your mortgage, imagine that aquarium filling up with water. When the aquarium is full to the top, then the house is paid off, and it’s all yours. The “equity” is the amount of water – the amount of the home’s value that you own.
Let’s say that you bought that condo for $500,000. You had initially put $125,000 down, and you now have a balance of $25,000 remaining on the mortgage. However, if you conducted an appraisal on the condo today, and it came back at $800,000, then you have built up $775,000 in equity on the property, more than 50% above the condo’s original value. Another way to look at equity is the amount of money that you would receive (less applicable fees and other transaction costs) if you sold the house today.
So if you have all that money sitting in equity, and you’ve come to a point where you need to use it, then taking out a loan or line of credit on that equity can make a lot of sense. Maybe you have a youngster heading to college. Maybe you have a chance to invest in another condo on the same block, but you don’t have enough to cover a down payment large enough to give you a prime interest rate. These are all good reasons to take out some of your home’s equity and start paying yourself back. If you live in a major urban market, you can take as much as 75% of your equity out in a loan (combined with your existing mortgage), while that usually tops out around 65% in rural markets.
Here’s one word of warning. If you do take out a home equity loan, or if you do use some of your home equity line of credit, that loan has the same force as your original mortgage. So if you fall into default on this loan, the lender can foreclose, just like your original mortgage lender can. So make sure you have it in your budget to make those payments on top of your regular expenses. You don’t want to get into a bind six months or a year down the road.
If you have other questions about your home’s equity, contact Amansad Financial today.