Investing in single-family rental properties brings many rewards, but perhaps none can grow an investor’s wealth better than equity. As residential real estate appreciates and any related mortgage principal is paid down, the equity on a property can become a significant asset on any balance sheet. When this happens, you may start to consider the benefits of pulling that equity out by refinancing the property. While there are many good reasons to do so, there are also situations in which pulling equity out of an investment property simply does not make sense. In what follows, we’ll take a closer look at when you should – and when you shouldn’t – pull equity out of your rental property.
Growing Your Rental Property Portfolio
Refinancing an investment property in order to turn the home’s equity into cash can be a great way to grow a rental property portfolio. Many investors have discovered the benefits of using the equity in one property to help finance their next property. This is a common practice, and when done carefully, can significantly enhance your cash flows and income. At the same time, however, it is important to examine the expected return realistically before moving ahead with such a strategy. Unfortunately, it is too easy to forget to include the higher mortgage payment on the existing property into your calculations. Be sure to run the numbers and gather all relevant information before adopting this strategy.
Another reason you should pull equity out of a rental property is to make capital improvements. All rental properties require regular maintenance, and over time, will need more expensive items like appliances, flooring, windows, and the roof replaced. As the condition of the property deteriorates, so do your property values. By using the equity in the property to improve the condition of the property, you are investing in higher future returns in higher rental rates, and thus ensuring the long-term profitability of your rental home. You are also making your rental home more appealing for tenants, who may be willing to stay in the property far longer if it is being updated on a regular basis.
Refinancing a rental property can also be a good way to consolidate higher-interest debts, although there are a few caveats that come with this strategy. Mortgages have much lower interest rates than credit cards and other types of loans. By paying off those higher-interest debts with a cash-out mortgage, you could potentially save hundreds if not thousands of dollars of interest in the long term. However, many investors have made the mistake of consolidating their debt only to run up the balances on their high-interest lines of credit once again, creating an unsustainable debt load. If you do plan to consolidate, first ensure that you have enough operating capital in the bank to make any additional borrowing unnecessary.
When You Shouldn’t Pull Out Equity
However, you should never pull equity out of an investment property is to purchase expensive personal items. There is a distinct difference between pulling equity out and reinvesting it into your business or even using it to eliminate personal debt, and pulling equity out to spend on things that don’t contribute to your business success. You may think that using a rental home’s equity to pay for that dream vacation or luxury item will keep you from paying extra for these things, but that may be a very expensive assumption. You should always carefully weigh the costs of any refinance against expected future income, and walk away from any strategy with numbers that don’t make sense. There are many good reasons to put the equity in your rental properties to work. But there are also good reasons to leave it untouched. Untapped equity may look good on paper, but in some cases, it may not be doing much to help you achieve your real estate investing goals. On the other hand, there are times when pulling equity out of a rental property doesn’t make sense. Every situation is different, and so you need to crunch the numbers and figure out when and if refinancing your investment properties makes sense for you. At Real Property Management, we offer rental property owners valuable tools and resources that can make such determinations easier. Contact your nearest Real Property Management office today to learn more.