Seeking Clarification On Leveraging Debt

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Seeking Clarification On Leveraging Debt

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Member since 2023 · 1 post · 0 votes

Hi All,

I am a new investor trying to figure out how to stretch my money out the furthest and I still can’t quite grasp the concept of leveraging debt. Here is an example that I would like to be corrected on:

1. Let’s say in an example I’ll choose a round number: I  have 500,000 to spend in a cheap market. I take 2% away for closing costs and am left with 490,000. Can I then put 20% down on 24 $100,000 homes, saving the extra 10k for reserves?

2. Can I then use an equity line of credit for 80% of equity, which would be $384000 and save 2% for closing, $7680, which would be 376,320 and put $20,000 down on 18 more houses?

- this would mean I have 98,000 of equity from the original 24 homes, and 360,000 in “equity” on the second set if that counts as equity even though it was financed with debt.

3. Do I “own” the equity I used the equity line for in the second round of houses? Where is the line in the sand for how far you can scale using this? Is it worth the risk of taking on so much debt?


I assume im not correct in my assessment and would like to know where I went wrong. 

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  • William Sing
    Real Estate Agent · Portland, OR · Member since 2020 · 278 posts · 136 votes
    3y

    You're on the right track in trying to leverage your initial investment to expand your real estate portfolio. 

    1. Initial Investment:
      • Closing Costs: You've rightly accounted for the closing costs initially.
      • 20% Down on 24 Homes: With $490,000, putting 20% down on homes valued at $100,000 each would indeed allow you to purchase 24 homes, leaving you with $10,000 in reserves.
    2. Equity Line of Credit:
      • LTV Ratio: Banks usually offer up to 70-75% LTV for non-owner occupied HELOCs. This means that with a 20% down payment, you wouldn't have accessible equity for a HELOC since your LTV would be 80%. To access equity through a HELOC, you would need to either increase your down payment or force appreciation of the property to increase its value and thereby your equity in it. For instance, if you put down $50,000 on a $100,000 home, you'd have $50,000 in equity. The bank would potentially offer a HELOC up to $75,000 (75% LTV), allowing you to access $25,000 through the HELOC ($75,000 - $50,000).
      • Additional Purchases: While your strategy to use a HELOC for further purchases is theoretically sound, it would be constrained by the LTV ratios and the actual equity you have in the properties.
    3. Equity and Debt:
      • Ownership of Equity: You would "own" the equity used from the HELOC in the second round of houses, but this comes with increased debt and interest payments on the HELOC.
      • Scaling and Risk: Scaling using this strategy comes with substantial risk, including over-leverage and the task of managing a large number of properties.

    Where You Might Have Gone Wrong:

    • Equity Calculation: The main area where your strategy encounters a hurdle is in the availability of equity for a HELOC given the LTV ratios applied by banks.
    • Risk Assessment: Leveraging can amplify both gains and losses, so a careful risk assessment is crucial.
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