While financial freedom gurus and seminar junkies might insist that going full leverage to build a real estate empire, it is a rather risky move when you are an inexperienced investor. The self-defeating irony is that the people most receptive to such radical ideas are newbies. Imagine if you had gone waist-deep into debts against everything you own towards your dream of becoming a property magnate before the subprime crisis when credit was loose. If that indeed was the case, unless you had a mountain of a vault full of cash or have a sugar daddy behind you, you would have probable lost everything.
The simple lesson to learn is that when you want to get a second property, you should avoid using your current home in order to get the loan. There are many risks involved in making a deal like this. The only scenario where you can get out unscathed is that by the time a correction occurs, your holdings have doubled in value, or if you have already got out. You may lose both your residential and investment properties if you are unable to meet the premiums and profits which you have desired to come out of this deal. But it is very important for you to know the basics of this kind of deal before making any notion.
When you like a property on which you want to invest on, you should check all your financial conditions before fixing to finally purchase it. If your financial condition is not in the pink of health, you should avoid investing on a new property, especially if you want to use your home for taking the loan. Because in essence, you will be borrowing money just so you can qualify to borrow more money. I don’t know how that sounds like to you. But it sure sound like something we hear out of Las Vegas gaming tables.
Generally, the loan to value on properties are high. Many times, buyers can get access to 5 times or more of what they put in as capital to purchase real estate. So people get allured to invest on some other mini properties in order to use the money by lending from their homes. But if the return value of the purchased properties is not promising, there could arise the situation of a big loss. These are very basic investment fundamentals that we sometimes forget when highly motivated to take action.
Some types of risks
In such transactions where a home owner takes up an equity loan so as to buy more properties, the ease of doing so can be so addictive that multiple layers of such transactions are created in very short space of time. This creates a house of cards where all it takes is just one to wobble for the whole structure to come crashing down. For example, a tenant who decides not to pay you anymore and refuses to leave the house for months. If cash flow is just enough to keep everything going like a well-oiled machine, this is bad new especially when you are already high on gearing after maxing out your equity loans from every lender and mortgage broker you can find.
For those who have just learned about the power of home equity loans, it can really look like a breakthrough concept that they cannot wait to take action on. But do notice that most of the time, the people who trumpet to others about such concepts have a stake in profiting from your venture to buy more real estate assets. Many of them are promoters of condominiums that are just the “right type” of houses you should put your investment funds in. Or they have just the right seminar workshop tailored for “people like you” over the coming week end at $2,997 a pop.
Many times, the theoretical success of such strategies look so easy and profitable. Yet not enough attention is put on the assumptions that these theories are based upon. Make no mistake about this. There are professionals out there apply these tactics and financial loopholes to profit from them. But do you really think for a second you can just join the club by visiting the bank and offer to put your house on the line?
Here is another way where things can quickly head south. In the event where property value have declined way past the mortgage, lenders have the option to recall a loan. When this happens you have to either quickly generate the funds to top up the loan, or allow them to foreclose it. How are you going to get more borrowed funds when you are already geared to the hills on all your properties.
Another risk concerns that of rising interest rates. When you have multiple mortgages to look after, a sudden sharp rise in interest can mean a sudden bill at the end of the month which your cash flow cannot manage. This can happen for real when you are on adjustable rate mortgages instead of those on fixed rates. In states where long term fixed rate loans are not available, you will always be open to such interest hikes.
If refinancing had always been part of your overall strategy, remember that you already have second or even third mortgages from the many equity loans that you will have taken up at this point. Depending on your income level or tenancy lease agreements, it could be difficult for any lender to approve anything if the current cash flow is unable to support additional leverage.
Just theory
The approach to real estate by using home equity loans to acquire more real estate is typically done by 2 groups of people. Those who know exactly what they are doing, and those who think they know what they are doing. There is no in-between that exist. The best advice when you don’t belong to the first group is to stay away, or find someone who belong in the first group to guide you. Investing in properties profitably is not easy, but the rewards can be overwhelming when you succeed. This take practice and knowledge.