Can Too Much Equity Be A Bad Thing?

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There are many reasons why people invest in real estate. Some investors look for the quick returns of a rehab or flip deal. Others want the security of the monthly cash flow that rental properties provide. Some are focused solely on building their portfolio by increasing their equity in the properties they own. The mistake that is often made is in thinking that equity is savings. Sure, it is better to have equity than, not but equity can be difficult to tap into. There are many hurdles and challenges with pulling equity out of a property you own. When all is said and done, few things carry more weight in the housing sector than equity, which begs the question: What does equity mean in real estate?


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Having equity in a home

What Does Equity Mean In Real Estate?

Equity is the difference in the amount you owe on any mortgages and the current value of the property. The bigger the spread between those two numbers the more equity you have. The first problem with assessing equity is that it is a moving target. Anyone that owned real estate last decade understands the dramatic swings equity can take. It was not uncommon in 2004 and 2005 to see homeowners pull equity out of their properties twice over a twelve month period. Values went up so dramatically that it allowed them to do so. On the flipside, values dropped seemingly overnight leaving many Americans upside down or owing more than their homes were worth. The first rule of understanding equity is knowing that it is just a current snapshot of the market and could change at any time. The equity you think you have today could be much different in six month’s time. There are other problems associated with taking equity out of a property. Here are a few of the most common issues associated with refinancing with the thought of tapping into your equity.

Low Interest Rates

One of the advantages of the market collapsing was the impact it had on interest rates. Over the past five years or so we have seen rates at or near all-time lows. Even with the adjustments made to investment property loan rates they were still far below average. This means that almost all recent purchases were done so with bottom barrel loan payments. Any type of cash out loan has an increase to the interest rate. This is before interest rates inevitably go up. It would not be a stretch to see a cash out loan increase your payment a couple hundred dollars. Depending on what you are using your equity for this could be acceptable. If the equity is increasing your debt than this could be the first step to financial trouble. If you are buying other property than you are doing it right. Regardless you will be paying more monthly for your cash at a higher interest rate. With rates have been there is seemingly only one way for them to go in the future.

Loan Amount Restrictions

Having equity alone doesn’t mean you can take it all out. The only way to see all of your equity is to sell your property. If you don’t want to do that but still want equity there are restrictions. Investment loan guidelines have started to loosen up but they haven’t yet for cash out loans. You are currently looking at loan restrictions anywhere from 70 to 80% of your property value. At 75% of your property value you still need to factor in closing costs and property tax escrows. This could reduce your cash out by $10,000 or more depending on your annual tax amount. This may not give you all the cash you want or need. Under this scenario it wouldn’t leave you with a lot of equity and wouldn’t fulfill your cash out objective. The more equity you take out typically the higher the interest rate. Having equity is great but only you may not be able to tap into it.

Length of Transaction

One of the problems with taking cash out is the length of each transaction. In most cases when you need equity time is of the essence. There may be a deal that you are looking at or a situation that needs immediate attention. With a cash out loan your best case scenario is 30 days with a more realistic timeframe of 45 to 60. Even if you opt to keep your first mortgage in place and seek out a home equity line of credit this will not happen overnight. Regardless of the loan you need an appraisal and the loan has to be underwritten. This process takes time and by the time your loan is approved you may have missed the window for your deal.

Property Value Fluctuation

You may have been waiting to tap into your equity for just the right time. When you get the right time the value you thought may not be there anymore. Property values are constantly changing. Every sale in your area has an impact on your property. With the number of transactions scarce in some areas there may not be many comparables to use. If the value goes down the loan amount will be reduced and the amount of cash you net will be impacted. Alternatively if you take cash out and values rise you may be stuck waiting for them to take off again. What you think you can do today may not be the case in six months when you really need the cash.

Summary

It is also better to have more equity than less. Equity gives you options but they may not happen in the timeframe you need it. Instead of focusing on equity look to add more properties to your portfolio or increasing your cash reserves. Equity may not be there when you really need it. What does equity mean in real estate to you?


Key Takeaways

  • Having equity in a home isn’t just a good sign for your debt-to-income ratio, it’s an invaluable tool for investors.

  • Pulling equity out of your house is entirely possible, but you need to know what you are getting into before you move forward with things.

  • Bad equity would suggest a homeowner is underwater, or that they owe more on the asset than it’s worth.