I received an email from a woman who is concerned about using her home equity line of credit to purchase a rental home. She is afraid that she won’t be able to keep it rented. If it were to go unrented for a while, she wouldn’t be able to make the payments, therefore might lose her primary residence as well as the investment.
That’s a perfectly valid fear. As with any other real estate investment, she would be taking a risk. Here are a couple of things to think about when making a “home equity investment” decision.
1. Evaluate the real risk. Find out if other rental house owners are having a hard time renting. To do that, look in the paper and call a few numbers listed in the classifieds under “homes for rent.” Be honest and let the owners / managers know why you’re asking. You need to know what’s really happening in your neck of the woods.
2. Run the numbers. What are similar properties renting for? Will you be able to cover payments? How much cash flow could be saved to help buffer an empty month or two? In general, using 100% financing is dangerous, because people usually borrow more than the investment property can pay. Yes, it may be easier for you to get the home equity credit than to go through the rigmarole of getting a traditional mortgage. However, it doesn’t matter where you got the money. If the investment can’t generate cash flow to make the payments, you need to have a darn good reason for getting into it.
3. Consider other financing. Your home equity is not the only way to skin this cat. One way to help remove the risk of losing your primary residence is by using your home equity only as a down payment, and getting traditional financing for the rest of the purchase price. That way, if catastrophe occurred and the property was generating no income, you still might be able to handle paying the home equity line of credit. Then you would just lose the rental property, and not your house.
[note: I don't suggest that you just stop making your mortgage payments without a word to anyone. That never ends happily.]
4. Consider your outs. If you do have trouble renting, how hard would it be to sell the property?
5. Consider other options. Buying a single family home to rent is not the only investment out there. Look at the lists Roger has been posting over the last few weeks for some ideas.
- Long Term Real Estate Opportunities
- Real Estate Investing for Mid-Term Profits
- Potential Short Term Real Estate Investments
In real estate, as in all investments, there is risk. Get all the facts, then make an intelligent investing decision.
Just a reminder - If you’re worried about the risk you take in real estate investing, check out our excellent (and cheap) report, Real Estate Risk Reduction Techniques.
{ 1 } Comments
This is a legit fear: Using you equity for something that requires cash flow and not knowing if the cash flow will be there.
I would say that for rental properties, as this case, it would depend on a few things. In most areas, the quick appreciation ship has sailed. If it is a buy and hold, like as in a retirement home, that would make more sense.
But buy a home in an area that you will hopefully see at least some appreciation. I would suggest retirement cities with modest housing prices. And ensure you dont buy a rental house you happen to ‘like’. Treat it like a business transaction…buy low and (hopefully) sell high. Look for bargins, distressed sales and easily rehabbed homes that will give a littl leverage to sell when the time comes.
If you pay retail and assume 5% appreciation (which is agressive), you will need at least 2-3 years just to break even after commissions, repairs and closing costs. That being said, there are some great bargins to had out there, but you have to look.
Work with an expert realtor and make them run numbers for you on rental history, cost of ownership and projected appreciation.
Bottom line is that if your cash flow is crunched with a rental property, do what you can to have the lender help you. They do not want the home back and will do things like defer payments, take interest only payments, allow you to make up past due payments over time. But remember, if you take a Home Equity Loan to buy a rental, you should have some equity in that home. So you may sell at a loss, but the lender may take a short sale cash settlement. Or you may be able to get a loan on the rental property. But make sure you get it before any loans get behind.
Just make sure you do your homework to determine the investment home is priced right, has a good chance of renting and is poised to appreciate.