You’re sitting on more home equity than you know what to do with.
At first you thought it would be nice to move into a bigger house, but then you realized that house prices are wild and you’d rather not pay those prices.
Then you heard a friend mention that they used equity in their home to invest. At first you weren’t too sure about using debt to invest, but then again, businesses and investors use debt to invest all the time. Why can’t you do it as well?
If you’re ready to start investigating your home equity investment options, this is the perfect place to start. Let’s dive in…
First, what is home equity?
Home equity is the value of your house that you don’t owe to anyone else.
You may have bought the house for $500,000, but you still own the bank for the mortgage on the house. Now, each mortgage payment is like buying back a little bit of ownership in your home, creating equity.
Other than mortgage pay-down, two other things contribute to equity, the initial down payment you paid when you bought the house, and appreciation (how much the total value of the house has increased).
Add all three together and you get your home equity, like this:
Down Payment: $100,000
Mortgage pay down: $100,000
Appreciation: $100,000
Total Equity: $300,000
Second, how do you “pull out” equity?
Just in case you haven’t done this before, here’s a brief explanation of how to “pull equity” from your home.
You can approach an mortgage broker or your bank representative and ask them about refinancing your house.
Depending on your situation, they’ll give you up to 80% of the equity in your home in cash. But your mortgage increases by the amount that you cash out.
So in our example, here what some of that math could look like:
80% of Total Equity Build up
80% of $300,000 = $240,000
The lender could put $240,000 cash into your account. But here’s what that does to your mortgage:
Current mortgage balance
(purchase price – down payment – mortgage paydown)
= $300,000
Plus refinance amount
= $540,000
Initial mortgage payment when you bought the house:
3% interest rate, 25 year amortization on $400,000 mortgage
= $1893 / month
New mortgage after refinancing:
3% interest rate, 25 year amortization on $540.000 mortgage
= $2556 / month
Your mortgage payment increases $663 per month. If you can shoulder that increase, you now have $240,000 to invest.
So the big question is, can you average more than $663 return each month on $240,000 to make it worth it?
Using home equity to buy rental properties
You could use that $240,000 for down payments on rental properties.
This is a true wealth building power play, but it is a lot of work. Not only do you get rental income (which also pays down the mortgage on the property), but your properties appreciate over the years as well.
So if you have the time to manage rental properties, or if you can afford to hire a property management company, then buying rental properties can really accelerate your journey to financial freedom.
There are several caveats though:
- One bad tenant or one major reno can set your profit back years. More about our personal experience with that here.
- The rate of return really depends on the city where you buy your rental properties. Make sure you’re running the numbers properly and accounting for any surprise expenses.
A big bonus about buying rental properties is that, after a few years, or after a major reno, you can refinance those properties as well. Now you’re compounding your investing power.
IMPORTANT NOTE: If you already invest in real estate and want new sources of cash flow, we wrote a report specifically for you. “How Real Estate Investors Find Cash Flow in the Stock Market” is our story of trying, failing, then trying again and making 100% ROI in the stock market. Download it now for free.
Using home equity to buy stocks
The stock market averaged 14% return each year for the last 20 years. Now, obviously that wasn’t a consistent 14%. One year it could be up 20%, the next it’s down 5%, then up another 10% after that.
But anyone with long term vision in that last 20 years has done well. Now, there’s no guarantee that the market will continue to perform that well in the next 20 years. So take this with a grain of salt.
A 14% annual return on $240,000 is $2800 per month.
One big caveat to this is that the monthly return is not a cash return. That’s just a monthly increase in the value of your investment. So if you need cash flow specifically, you may need to look at other investment options.
You could invest in dividend stocks, which pay quarterly cash dividends. Those returns range from 3% – 6% on average each year. That’s a monthly return of $600 – $1200. And that is on top of your stock appreciation.
Imagine those kind of returns in a maxed out TFSA or RRSP account!
And there’s not a whole lot of work involved when buying stocks to hold for decades.
Using home equity to cash flow with stock options
This requires a little bit more education and work. But it takes a lot less work to cash flow with stock options than it does with rental properties.
We won’t go into the mechanics of finding cash flow with stock options here. We wrote an “Options for Beginners” series just for that. Check it out if want to learn more about how they work.
Back to using home equity to cash flow with stock options though.
One of our Stock Hacker Academy instructors, who employs a very conservative strategy, made a 12% return in 2021. He placed 31 trades and 30 of them were profitable.
12% of $240,000 is $2400 per month. And that is cash in your account each month.
Plus, there are different stock option strategies that let cash flow on stocks you already own. So you get stock appreciation, possibly dividends, and then cash flow from the options trading. If you want to see how much you can make this way, read our article about making $1,000,000 in registered accounts.
What do I do with this information?
This is just the start.
Your first step is to find out much equity you can get access to. Make sure you crunch the numbers to see if you can shoulder the extra mortgage payment, should your investments fail. You always want to be protected.
And you don’t have to take out the full 80%. You can refinance up to whatever amount you deem necessary (and that you’re approved for).
Next, decide how much work you want to put into these investments. Are you willing to put more effort into this? Rental properties might work for you. Are you looking for “set-it-and-forget-it” strategies? Buying stocks could be your best bet.
Do you want to add more cash flow to what you’re already invested in? Then stock options could be your play.
And why not mix and match, if you can. Having real estate, dividend stocks, and stock option cash flow means you have multiple streams of income, protecting you from disaster if one market fails.
So have a conversation with your mortgage broker to see how much home equity you have access to, and continue learning.
That’s all for now.
Happy trading,
Your fellow Stock Hackers,
🍒Cherry & Erwin
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