Any good strategies for using equity in existing home for investing?

Question

My wife and I have kicked around downsizing from our rather large paid off home to something smaller and then using some of the cash received after we pay off the smaller home for RE investing. I wondered, though, if there were any good strategies outside of a home equity loan for just pulling a very small portion of our equity out and investing in 1-2 properties?  Any smart ways of doing this or is the idea just plain bad?

Bill Exeter · Answer

I wanted to clarify a portion of Roger's post above.  The Tax Act of 2008 changed the strategy that he has suggested.  The capital gain must be allocated between the number of years the property was held as investment property vs. the number of years it was used as your primary residence. The capital gain allocated to investment property is still taxable (does not qualify for tax-free treatment under Section 121) and the capital gain allocated toward the primary residence is tax-free up to the $250K/$500K limits.

Aaron Mazzrillo · Answer

I am totally against leveraging your primary residence to invest. Just a gamble I don't think is worth taking. If things don't work out, and they sometimes don't, you risk losing your home, which could lead to some severe marital problems. Money problems are the number one reason for divorce. It just isn't worth it.

And, if you didn't lose your home, you'd be reminded of the mistake you made every single month when you pay the mortgage. That is one ongoing seminar you don't want to take.

Now, selling your house, buying a smaller house and using the left over (section 121 excluded money!) to invest is a great idea. If you lose the principal, you still have a comfortable place to sleep and strategize (my browser red underlined that and says it is not a word!) how to get back out there.

Bill Gulley · Answer

I wasn't giving investment or personal financial advice, but I agree with those above too, be very careful starting out and using your home. If you do use the equity consider not encumbering the property to the extent that selling it wouldn't cover the mortgage or encumbrance, costs of sale and enough left over to get a paid off roof over your head.

As your experience increases then that picture may change but always leave enough to regroup from any event and come out above water. :)

Abdul R. · Answer

I heard from an rental expert, and I thought it wade sense, that it is great to rent (not own) expensive/large properties (you get a great deal being a tenant) and then to own several not-so expensive properties to rent out to others (you get a great deal being a landlord). In the first case the rent-to-value (RV ratio) will be much less than 1%. In the latter > 1% (inching close to 1.5% or the 2%).

Roger Lin · Answer

Bill, Thanks for the correction.

Roger

Scott W. · Answer

take the HELOC out and do a rental with 30-yr leverage. cheap $ out there.

let me ask you this - where else are you going to get triple digit returns?

Alison M. · Answer

After going from a reliable paycheck to self employment 5 years ago, I am adamant that I will *never* take on another mortgage again after we sell our current residence.  I don't know your other financial circumstances Robin but unless you've got an annuity that covers your mortgage or another iron-clad income stream I would keep your paid off house just like it is - paid off.

Roger Lin · Answer

Robin,

You are in a great position.  Does your home make a good rental property?  Will it give you good income and is it in a good condition and in a good school district that people want to live in?  If it is a good rental too.  You can refinance to take some cash out of it and use the proceeds to buy yourself a smaller home to live in.

The larger home will probably bring you a higher rental income, higher loan amount.  Also, this way, you only have one purchase transaction, your smaller dwelling.

Finally, once you turn your larger home into an investment property, you can 1031 exchange it into a larger investment property (deferring capital gains tax) and keep doing it until you are tired of investing, then move into that last property, live there for two years as your primary residence.  Sell it without paying capital gains (if your profit is less than $500K).

You will come a full circle and avoided a lifetime of capital gains.

Roger

Bill Jacobsen · Answer

The question seems to be, "do I go into debt or downsize"?.  The safest way is to downsize but you may not be willing to do that.  We use our HELOC from time to time to buy investment properties.  I like to earn at least 3 percentage points above my cost of money.  My HELOC is about 4% so I need a return of at least 7%.

Bill Gulley · Answer

If you must play with cash you get a HELOC or second. If you don't need cash you can assign interests, give a secong to a seller, use a blanket mortgage with a seller in seller financed deals, wraps, options and leverage the deals with your equity. Only four ways to use equity, assign it, sell it or borrow it or rent it. :)