Is Leveraging a Good Idea?
The unofficial cardinal rule of investing in real estate is that you invest, or buy real estate with someone else’s money, not yours. This is the basis of leverage in the Chicago real estate investment market; by using someone else’s money to invest in real estate, you are making gains from your lender’s money.
Leverage is a well-known strategy in the Chicago real estate market, and it is the most widely used way to acquire real estate. There is a drawback though; when real estate values rise, it is to your advantage. But when they fall, you are at a disadvantage. This is why it is crucial to do your due diligence about a property when you want to use leverage to acquire it.
Leveraging Your Way to the Second Mortgage
Simply put, a second mortgage is a mortgage taken out when you still have a mortgage in effect on your first property. Doing this is only possible if you have enough equity on your first mortgaged property since a second mortgage is a riskier endeavor than the first.
The usual practice is that your first property is used as collateral for the second mortgage, and most lenders will only agree to a deal if you have enough equity on your first property. This is the big risk with leveraging property to buy the property.
The second mortgage can be used for anything, including using them to service personal expenses.
Types of Second Mortgages
There are basically two types of second mortgages available for use in the Chicago real estate market. They are;
- Home Equity Loans
- Home Equity Line of Credit (also called HELOC)
1. Home Equity Loans
Home equity loans are a type of second mortgage in which you can borrow a certain amount of money in a lump sum, payable over a period not exceeding 15 years at a fixed rate of interest.
Basically, you are using the amount of your home you own (i.e. the amount of mortgage you’ve already paid back on your home) to back up your credit. If you fail to pay, your house is liable to be foreclosed by the lender.
Home equity loans are best for investors looking to leverage their property to buy a rental property, as rental properties usually require a significant amount of down payment.
2. Home Equity Line of Credit
Popularly called HELOC, this type of second mortgage is different from regular home equity loans in that they are payable with adjustable rates.
HELOCs are the credit cards of second mortgages, and they work in a similar manner; there is a credit pool you can repeatedly draw from, it has a set limit and some lenders even give you an actual credit card. HELOCs have draw periods in which you can draw from the credit pool as you need the money, without having to pay back. This draw period is between 5 to 10 years.
HELOCs also have repayment periods, wherein you pay back all the money you have borrowed at adjustable rates, as mentioned earlier.
How Do You Leverage One Property to Buy Another?
There are two ways to do this, put simply. They are;
1. Leverage Rental Property to Buy Another
A rental property is a good investment if bought properly. Managing it yourself might not be easy, which is why we advise that you use a Chicago Property Manager, or a Chicago property management company, such as Lofty Real Estate.
Using your rental property as leverage to get another property is the easier of the two ways of leveraging property to buy another property. This is because the rental income paid by tenants can be used to pay up the mortgage on the rental property and gain some equity.
Using a rental property as leverage for buying another property would involve using the rental property as collateral, as mentioned earlier. A second mortgage would also involve higher interest loans than the first, so you have to be absolutely sure your primary property has enough equity to cover the expenses associated with taking a second mortgage.
2. Leverage Your Primary Residence to Buy Another
Another way of leveraging property to buy property can be this scenario; using the equity on your primary residence to get another mortgage. It can be another house or even a rental property. Doing this will mean your primary residence will be at the mercy of the lender if you default on the second mortgage payments.
Requirements for Leveraging Property to Buy Property
Building up a good level of home equity and a great credit score are central to the success of your chances when taking out a second mortgage.
How to Get A Second Mortgage
1. Know How Much Equity You Have
Knowing how much equity you have will help you make a quick decision on whether or not to go for a second mortgage and leverage your property to buy property. The more equity you have, the more your chances of success when it comes to your application for a second mortgage.
2. Check Your Credit Score
This is also another key part of the process. An excellent credit score will also improve your chances of being approved. If you’re interested in leveraging your primary property to buy another property, then you have to possess a credit score to match.
3. Pick out Your Preferred Second Mortgage Option
There are two options for you here, either you go for a HELOC or a home equity loan. Each option has its own peculiarities and benefits, so be sure to pick one that suits you. If you’re leveraging property to buy another house, going for a HELOC might be best. On the other hand, if you’re leveraging property to buy a rental property, then going for a home equity loan where you’ll get a lump sum might prove to be the better option.
4. Look Around
Once you’ve carried out these three steps, then it’s time for you to find out the options you have with regard to lenders and their rates. Check out the terms of each second mortgage very well, and ensure you don’t sign until you’re convinced it’s the best deal for you.
In Conclusion
