For those who have several properties, one investment strategy that has been touted around for a while now is releasing capital and living off the equity.
The strategy works on the principle of you borrowing against one of the properties and you use that loan to live off. In the meantime, your property portfolio continues to increase in value and you still have all your assets.
Advocates for this strategy highlight because you’re borrowing money, you don’t need to pay any tax (talk to a financial specialist to make sure).
Users of this strategy tend to borrow a relatively small amount to live on, for instance around $100,000. They use the rental income for both the loan repayments and to live off; the idea is the loan will eventually be paid off by the rental income.
If the interest rates rise for whatever reason, advocates say you can increase the rent accordingly.
On paper, this strategy looks great. Rent is paying off the loan, you’re effectively living off a tax-free income and you’ve still got all your assets.
Still in debt
But, and it’s a big but, you are funding your lifestyle by debt and you need to make regular payments to service that debt.
The reality is you are effectively putting yourself into further debt without actually having anything to show for it. Think about it; you’re actually spending your wealth rather than your cash flow. Because you’ve borrowed money against an asset, you’ve effectively reduced your net worth.
Pay down the loan
Many consider it a better strategy to pay down the loans or not touch them at all. In the meantime, your property is increasing in value, so your assets are actually increasing in value.
There will come a point where you can sell a property to pay down the loans further and then you can live off the rental income. Yes, you’ll have to pay some tax, but your asset base will be greater and the amount of money you owe will be less.
Property is a long-term investment and like any investment, it’s not without risk.
What happens if there is a massive rise in interest rates, a property isn’t tenanted for a period of time or it needs major maintenance or repairs?
The key to good property investment is understanding the risk and having strategies in place to reduce them. Borrowing more money against a property and not having anything to show for it is very risky.
Many investors prefer to use any money borrowed against properties to buy another property or asset. Thereby if there is a downfall, they at least have something of value to sell.
The best thing to do is to speak to an independent financial specialist who can fully explain all the risks involved with equity loans and come up with a solution which best suits your financial interests.
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