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Should I Use the Equity In My Home to Invest In a Condo?

Is using the equity in your home through a HELOC (home equity line of credit) a wise way to invest in pre-construction condos? What are some strategies that can be used? What are the risks? Is it better to pay for investment condos with cash? Andrew la Fleur discusses all these issues and more on this episode.

Click Here for Episode Transcript

Andrew la Fleur: Should you use a home equity line of credit to invest in a new condo? I’ll give you my thoughts on this question on today’s episode.
Speaker 2: Welcome to the True Condos Podcast with Andrew la Fleur. The place to get the truth on the Toronto condo market and condo investing in Toronto.
Andrew la Fleur: Hello and welcome back to the show. Once again, we’re going to be asking the question as I said in the intro of should you be using your line of credit, a home equity line of credit to invest in a new condo? It’s actually something that I talk about a lot with clients. It’s a very common subject, but I realize I haven’t really produced much content on this issue in terms of articles, videos, podcasts, that sort of thing. Obviously, you were overdue and I thought it’s definitely time to do it. It was brought to my attention again this week. I was speaking to a regular listener of the show and the client who mentioned that this would be a subject that he’d be interested in hearing about on the show. Also, just this morning got off the phone with a potential new client who was asking the very question. They’re wondering about, as they’re thinking getting into condo investing, should they be using their line of credit. Is that a good strategy to employ for investing? Without further ado, let me get to my response to that question.
My answer is definitely yes. Absolutely, 100%, if you have access to a home equity line of credit, then you should be using that money to invest in a new condo. Obviously, there are caveats to that and every situation is different. Obviously, the big one I got to say is I’m not an accountant, I’m not qualified to give financial advice. You want to speak to your accountant or professional wealth manager, financial planner, that sort of thing for advice on your specific situation. In general, using a home equity line of credit can be a very, very powerful tool for growing your wealth and accelerating your wealth generation through real estate or really through any cash flow producing asset other than real estate. Real estate, obviously, is what this show is all about, so we’re talking about that here today.
The general principle here is that money is cheap. Money is very cheap right now. Historically cheap and it has been for many years now. Home equity lines of credit, the interest rate now, you can get approximately, and the assumption that we’ll use for this conversation when we talk about numbers is 3%. Basically, you can borrow money against your house if you own your home and you have excess equity in your home, you can borrow that money at 3% interest approximately. The idea simply is that if you can borrow money at 3% and you can invest it at some number that is higher than 3%, of course you should do that. You are making money using someone else’s money. It is free money in a sense. If you can borrow at 3% and invest at 4%, you are going to make 1% return on money that is not even yours. This is just free money falling from the sky into your lap. It is a very rare and interesting opportunity that you can take advantage of.
Of course, if your investment goes sour, then your losses are compounded by the fact that you have borrowed money to lose money. That is a horrible situation to be in, but if you’re smart and if you’re wise and if you’re prudent and if you invest strategically, you can do what many, many millionaires and billionaires have done to create their wealth and that is using other people’s money. OPM as some people call it. OPM to make more money and to grow your wealth. It’s a concept of leverage and it’s been used for centuries, maybe longer, to grow wealth. In times like we’re living in today, in 2016, again, historically low interest rates. Money is historically cheap right now to access and to borrow. At the same time, assets are appreciating at historically high rates, so it’s a perfect combination where if you have access to cheap money and you can put that money into an appreciating asset and asset that pays you a dividend, that pays you cash every month, it’s really not that complicated, but a lot of people are new to this concept.
A lot of people, this is a foreign idea to them. Quite frankly, I think it’s just because a lot of people are brought up with and are raised with and our culture teaches us that debt is a bad thing. That liabilities are a bad thing to have on your balance sheet. You don’t want to owe anybody anything. A lot of people still have this concept in their heads of “I got to pay down my mortgage as fast as possible.” You see articles and books and we celebrate the 28-year-old, 38-year-old, whatever-year-old who has paid off their mortgage and rips up that mortgage paper in dramatic fashion. It makes for a great photo op and champagne is popped at this concept of living without debt, but rich people and wealthy people and people who own businesses look at that and they just shake their heads and say, “That person is an idiot. That person doesn’t understand that debt is not your enemy.” Debt is a tool to be used when used wisely that can dramatically increase your wealth, but not just increase your wealth, increase the rate of acceleration of the growth of your wealth. That’s the general answer and the thinking behind it.
We can do entire books and 15 podcasts just on this and maybe we will eventually. This is more of an overview episode today. That’s the overall concept behind it. I want to look at a couple of strategies, basic strategies of how you can use this home equity lines of credit. Two basic strategies. Number one is you use your home equity line of credit to buy pre-construction condos right now. If you saw, most people do not have tons of cash sitting there floating around. Using your home equity line of credit is a great way to access capital quickly and cheaply to be able to do things that you otherwise would not do if you’re waiting for cash. Let’s give a hard, real, actual example. Let’s say you wanted to invest in a condo today, but you don’t have the cash to pay the 20% deposit. Let’s say that the condo, for this example, $300,000 condo. You’re going to buy a studio or a small one-bedroom unit somewhere downtown, let’s say $300,000. You need 20% deposit. You need $60,000 for the deposit to purchase that condo that’ll be built in four years.
The first alternative is you can use your home equity line of credit. If you have excess equity in your house that you’re able to tap into, let’s say at 3%. Let’s say pull out the $60,000 all of it at 3%. It’s going to take four years to get built. Again, the nice thing about home equity lines of credit is you can do interest-only payments, so it’s very friendly on your cash flow and your pocket book at you’re maintaining your existing lifestyle and only paying the interest-only payments. If you’re paying interest-only payments over four years on a $300,000 condo that you borrowed $60,000 for the deposit, that is going to be approximately $7,200 in interest over four years. You’re adding that effectively, $7,200, you’re adding it to the price that you’re paying. If somebody comes in and pays cash, they are essentially, for the deposits, they’re paying the $300,000. If you come in and borrow the money for the deposits at 3%, you’re paying about $7,200 in interest on $300,000. You’re adding about 2.4% to the price. When you think about it like that, you’re adding about 2.4% to the price if you’re financing. If you’re essentially financing the deposit, 2.4%. First alternative.
Second alternative. You say, “I don’t want to do that, that doesn’t sound good, Andrew, adding money to the cost. Don’t we want to buy it for lower prices? Don’t we want save money?” Let’s say you decide you know what, I’m not going to use home equity line of credit. I am going to scrimp and scrooge and save and put aside money every single month from my normal budget. I’m going to save cash. I’m going to make it a goal to save cash until I can have enough cash to purchase the condo and pay for the deposits in cash. Okay, so, if you’re starting from zero and you’re an average person or even above-average person in terms of earnings, it’s probably going to take you, let’s, for this example, say it’s going to take you four years to save up $60,000 of extra cash to make this kind of investment.
Assuming it takes you four years to do that and in four years from now you purchase a condo with $60,000 cash for deposits, here’s the problem. The problem is that that condo that you could have bought today for $300,000, in four years from now that condo, let’s say even if it appreciates at a very conservative 3% per year, which is about half of the historical average for the GTA appreciation rates, 3% a year over four years, that condo today that’s $300,000 in four years, conservatively, that condo is $336,000. It’s gone up 12%. The opportunity cost, the 12% increase in price versus the 2.4% increase in the price if you purchase it today and you finance the deposit. Buying it, in effect, for $307,000 today is much better than buying it for $336,000 four years from now. There’s one example and one concrete way of looking at and understanding it.
Everyone’s situation is different. The average person, I said probably take a few years to save up $60,000 in extra cash from your current lifestyle. If you’re able to save up $60,000 in a month or two months or three months, it’s a very different scenario than the person who is taking a few years to do that. Every situation is different of course, but that is the general idea and concept that you need to think about and numbers that you need to run for your situation to see what makes sense for you. Because the market keeps moving. The market keeps passing you by, so if you have an opportunity to get invested into the market with capital that you have access to, whether it is cash or whether it is debt through your home equity line of credit, in the current market that we’re in that is moving up, it is a great time to use debt to do so. That is the first sort of general concept is yes you want to use your home equity line of credit to purchase pre-construction condos today. It is a good idea. It is better than the alternative of saving up cash and waiting one year, two years, three years, four years to have enough cash to be able to do that.
The second strategy and the second basic, practical way that you can use this tool of equity is through refinancing. If you own a home, you can use that debt to purchase an investment condo. The second thing, is if you purchased an investment condo, pre-construction, and then let’s say you buy that condo today at $300,000 and then four years from now the condo is worth, let’s say, again, it appreciates at, very conservatively, 3% a year, so in four years it’s worth $336,000. On completion of the condo, what you can actually do, depending on your lender and your personal situation. Again, consult your experts on this area, but what a lot of investors do is they pull their equity out right at the beginning.
You bought it for $300,000, you put $60,000 down, it’s now worth $336,000 at the time that the building is actually built in four years and when you need your mortgage. You can actually pull out some of that equity growth that you’ve experienced. You’ve seen an on-paper growth of $36,000. You can actually pull out approximately $28,000 or $29,000 of that $36,000 equity growth, assuming that the property is appraising at $336,000. You’re putting down $60k and then when the thing is built, you’re pulling back out, you’re essentially getting a check back for about half that amount. It’s almost as if you’ve really only put down half that amount. You put up $60,000, four years later, you get a check back for $30k, and you still own that condo and it’s now rented out and it’s now paying for itself and will hopefully have positive cash flow, of course, as well.
What do you do with that $28,000, $30,000? Obviously, you use that to reinvest into another property and you rinse and repeat that process over time. Now, again, we’re using conservative numbers at 3%. What if that property actually appreciated at the normal historical rate, which is 5% to 6%. Let’s call it 5%. If it appreciates 5% a year over four years while it’s getting built, that’s 20%. If it goes up 20% and you put down 20%, you basically have an opportunity to pull your full deposit, which is very interesting. You put down the 20%. You wait. The property has increased in value. You take back the 20% that you put in and you still own the property and you still are getting income from it. Someone else is paying down your mortgage and the property continues to appreciate.
Again, this is a basic overview, a quick overview. Might make sense to you. Might need more time to sink in. This might be old news. You might be saying, “Yeah, Andrew, I do this all the time,” but I wanted to get into this episode and speak specifically to the people for whom refinancing and using home equity lines of credit to invest is a new idea or new concept or is something that think is actually a bad thing. I’m trying to help you understand that it can be actually a very good thing. Again, understanding the risks and understanding your unique situation and getting advice from a professional, but this is how wealth is created. This is how the wealthy, the rich get richer. This is one of the tools that they use and understand is the power of debt in growing your wealth. Hopefully, this episode was useful to you and you found it interesting. Thank you for listening. Thank you for giving me feedback on all of these podcasts and continuing to give me great ideas every week, every day to talk about on this show. We’ll continue to get into the topic of refinancing in future episodes and future articles and videos and things, but hopefully this is a start to get the ground rolling. Okay, until next time, we’ll talk to you soon.
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