How to turn your home’s equity into an investment property down payment

BY CLEVE DESOUZA

Have you ever thought about buying a Toronto area commercial building, condo, or vacation home to use as an investment property? Many people like the thought of real estate investing, but immediately shut down the idea because they believe that it isn’t financially obtainable for them. While buying an investment property does require up front capital, it can be doable with the right strategy. One great way to get started is by cashing in on the existing equity that you have in your home!

What is equity?
Equity is the difference between what your home is currently worth and what you currently owe on it. For example, if your home is valued at $650,000 and you owe $300,000 on your mortgage, you have approximately $350,000 in equity. As real estate values increase and you make monthly mortgage payments that include principal reduction, this amount continues to grow over time.

How people use equity
Many people choose to just leave their equity alone, allowing it to accumulate and grow over time. Others cash out some of their equity from time to time to pay off higher interest debts, make big purchases for their family, or improve/upgrade their home as needed. While there is nothing wrong with these uses of equity, there is another way to utilize it that could reap bigger financial rewards in the long term. 

Down payment potential
One of the biggest challenges of buying an investment property is obtaining a sizable enough down payment. Unlike mortgages on a home you will live in, most lenders will not lend as close to the full purchase price amount on investment properties. This means that a larger down payment is required, usually around 20%-25%. One way to meet this requirement is with a home equity loan or a cash out refinance.

How much cash can I expect?
While every lender is a little different, most will loan you up to 80% of the value of your current home. In our example above with the home that was worth $650,000, a likely cash out loan amount would be about $520,000. Subtracting the $300,000 mortgage owed and several thousand dollars for refinance fees leaves approximately $210,000 in cash available that could be turned into an investment property down payment.

How much can I buy?
Now that you see the cash potential for a down payment, you probably are wondering how much of an investment property this down payment amount would allow you to buy. This number is often a moving target, because there are so many factors (like repair costs, property type, personal credit, etc.) that figure into the final calculation. However, a good place to start is about three and a half times your down payment amount. In this example, your investment property budget should be around $735,000. This allows for a sufficient down payment (up to 25%) and still leaves cash available for closing costs and small repairs.

The bottom line
If you have been dreaming about taking a leap into buying an investment property, and have some equity built up in your current home, then this might be a viable strategy to employ. Discussing the idea with a financial advisor or financial strategist is a great place to start and will give you a better idea of how this strategy could work with your personal situation.