YOU’VE GOT LOTS OF EQUITY: NOW WHAT?

While our government is pushing mortgage rates up in the hopes of slowing down the US economy to stem the recent rise in the cost of everything from milk to automobiles, many of us are wondering what opportunities exist for small individual investors. The US stock market is down 11% year to date, and down 6% over the past 12 months. Bonds are taking a beating, and inflation is outpacing Certificates of Deposit by nearly 3-1. Where can we find a reliable and attractive investment for our savings? And perhaps even more importantly, how can we manage the equity in our homes more effectively and efficiently? Experts tell us that nearly 80% of Americans will rely on the equity in their homes for most of their retirement funds, yet few of us know how to effectively manage our accumulated equity. Many savvy homeowners realize this simple bit of logic: if more and more people are unable to afford a home due to rising interest rates, those people unable to afford a home will have to continue renting. Ergo, rental properties will remain highly sought after and may even increase in demand as the home buying frenzy of the past two years subsides.

We already have an acute shortage of rental properties due to the ‘Great Recession’ wiping out nearly a decade of rental property development. In 2008, the subprime mortgage crisis spawned a huge recession in the home and apartment building industries nationwide. We lost over 80% of the national builders and some markets like Phoenix saw nearly all small builders go bankrupt. And yet, our citizens continued to do what they do. They got married, had kids, got job promotions, transferred jobs from one city to another, got divorced, retired, downsized their homes, etc. In short, life went on. As a consequence, the need for new homes and apartments went on but without the usual supply. This shortage of livable residences has been with us now for 7 years. And as our national and local economies rebounded and grew more robust, the amount of demand for new housing has grown too. Even a global pandemic has been unable to quench the thirst Arizonans have for housing, until now. Now, we are told, low and moderate-income homebuyers are stymied from buying homes. The amount of homes for sale is rising slightly, but with mortgage rates up 2.5% over the past 12 months, affordability has plummeted. These buyers are now realizing that unless they radically adjust their housing goals by agreeing to much smaller homes or homes much further from their jobs than they had hoped, they will not be able to buy a home anytime soon. The search for affordable rental homes is heating up along with our desert temperatures. Those of us who own rental homes are enjoying strong demand for rental properties and are increasing rents as a result. Herein lies an opportunity for the little guy, the individual investor looking to use their equity to earn a fair return.

Thus, if you find yourself with a piece of residential real estate that has appreciated greatly in value over the past few years and you wish to use that equity to purchase rental housing properties, you may want to consider the following information. First, to access the equity in your home you would typically need to either refinance or sell the property. Doing a refinance right now is painful because you probably have a very low-interest rate mortgage that you would hate to pay off in favor of a larger loan at a much higher current rate of interest. And selling your property is not an option either because we’re talking about your primary residence and you like living there and it’s a great investment that continues to appreciate. So, how does one go about liberating some of the equity in their home so that they can use that equity to buy a piece of rental real estate? The answer to that question is simple: a Home Equity Line of Credit or Home Equity Loan. However, there is a huge difference between these two types of financing tools.

Accessing the equity in your home can be easy, inexpensive, and may not even require an appraisal. A home equity line of credit is often referred to by the acronym HELOC and can be thought of as a big credit card that is secured by your house. You are free to use this line of credit as you see fit typically for 10 years. You can draw against the line of credit, you can pay the line of credit down, you can draw against it again in the future and pay it down again as many times as you wish during those first 120 months. You only pay interest on the amount that you owe at any given time and your monthly payment requirement is interest only. At the end of 10 years, you’re typically required to pay off the remaining balance in equal monthly payments stretched out over a 20-year period. All of that sounds good and for people who have had HELOCs over the past 10 years, their interest expense has been very low because interest rates have been very low. However, this type of second mortgage is by its very nature an adjustable-rate mortgage. Every month your payment is recalculated by taking a familiar financial benchmark called the INDEX and adding to that a specific amount known as the MARGIN. For instance today the most typical index is called PRIME rate which is approximately 4%. Most lines of credit would add somewhere around 1.5% as the margin to that index, meaning that your effective interest rate this month would be 5.5% Now consider that this same type of loan a year ago was around 2% less expensive than today and that two years from today the same loan might require payments based on interest rates 1%, 2%, 3% or even higher than today. HELOCs typically do not have any CAP and your interest rate and thus your monthly payments can continue to rise throughout the life of the loan. That’s a little scary.

As an alternative to a HELOC, VIP Mortgage and other financial institutions are offering a HELOAN. This type of loan features a fixed rate with a known loan term. The consumer knows exactly what their monthly payment is going to be each month for the life of the loan. In my view, this is a much more reasonable method of accessing your equity to raise the money for a down payment to buy a rental home. Others would suggest that you could use money from your 401(k) for the same purpose and for some borrowers this might be a good idea too. Whether you use financing to access the equity in your home or you tap into your retirement savings to invest in rental property, the point remains the same. Purchasing real estate in Arizona to place into rental service as a long-term investment is a very popular idea and one not solely reserved for corporations and big-time investors. The little guy can invest in rental real estate too.