Climbing the property ladder: leveraging equity

With property prices climbing, more and more people are seeing the value of investing in real estate. Whether you’re upgrading to a bigger place, buying a vacation home, or investing in rental properties, getting up to the next rung of the property ladder can be a smart way to build wealth. We talked to mortgage broker Scott Nazareth and Property.ca agent Cameron Miller about the best strategies for climbing that ladder.

Getting started

You don’t have to have a ton of money saved to buy a second property: the key is using the equity in the home you already own. Most people tend to think they need to sell their property to buy something else. But that's not the only way to go. You can use the equity you’ve built up in your current place to buy something else – without selling.

With the way markets have been performing, if you've owned your home for 3-5 years, there’s a good chance you're sitting on some significant equity. (Equity is a combo of what you’ve already paid towards your principal and the capital appreciation you’ve accrued as your place has gone up in value.) Whether you're looking to move up to a bigger property or you want to start building a portfolio of rentals, using that equity can be the quickest path to your goals.

“If you sell a property, you may get money for it, but you lose an asset – and the earning potential it holds,” says Cameron. “By borrowing against your equity, you’re getting the money you need, earning rent to help pay down your loan AND keeping a property that will potentially go up in value. A lot of people are afraid of debt, but this is good debt: it builds wealth.”

So what does leveraging equity look like?

Let’s say you and your significant other own a one-bedroom condo downtown. You’ve been there for a couple of years, but you’re both working from home, kids are on the horizon and you want more space and a place with a backyard. You have a couple of options:

1. Sell the condo and put whatever money you’ve made towards the house.

2. Hang on to the condo. Borrow against the equity to help supplement your down payment, and rent it out so a tenant can cover your costs and carry the loan with minimal cost to you.

Of course, you may have to sell your current property to be able to finance something bigger – if you haven’t owned the place long enough to build enough equity, you may not have a choice. With average house prices well north of a million these days, getting a down payment together isn’t easy. But if you have enough equity built up and you need some help getting to that magic 20%, you don’t have to sell: you can borrow against that equity to supplement your down payment.

“The 20% down payment you need to purchase a property over 1 million dollars can be tough to achieve through savings alone,” says Scott.” By taking on a small amount of additional debt through refinancing, you won’t just have one asset growing in value – you’ll have two. And like magic...you now have a real estate portfolio!”

As you pay down both places and they both go up in value, other opportunities may present themselves: maybe you can leverage the capital appreciation again to buy a cottage or a property abroad. Or you can invest in more rental units to build up your budding real estate empire.

Read more: Ask a tax pro: selling an investment property

What does refinancing involve?

Refinancing is when you renegotiate the terms of your existing mortgage to access additional equity. It starts with getting an appraisal to determine its current market value so know how much you can borrow: the cap is 80% of the value. If a property appraises for a million, for example, the max you could get would be $800,000 (less what you still owe on it).

If you're looking to refinance but think you might need some flexibility around payments and don't want to lock the entire amount into a mortgage, consider structuring part of your loan as a home equity line of credit. Scott recommends setting one up so if you need to access money quickly (for something like a repair, or if your tenant moves out and you have to carry expenses for a little while), you can borrow what you need, when you need it.

“Refinancing may not always make sense because the penalty to break a mortgage – especially a fixed-rate mortgage – can be high,” says Scott. “Having a home equity line of credit, however, means you can access equity without touching your mortgage at all, so you don’t incur any penalties. There are some additional considerations: you’ll need to get an appraisal, you’ll be paying a higher interest rate and you may face restrictions on how much you can withdraw, but it’s worth setting up for the flexibility. With a HELOC, you can withdraw funds at any time and also pay it off at any time, just like a credit card, but at a much lower rate.”

How can I build up a larger portfolio using this strategy?

Once you’ve bought one property using your equity, the same principles apply for future purchases. You just keep borrowing against the equity in something you already own to finance your next purchase. (Just rinse and repeat.) Cameron illustrates the process with this formula:

“Say you buy a $500K condo and you put $100K (20%) down,” he says. “After 3-5 years it's worth $600K. You pull out your initial investment, put it down on another property, and keep going. You can quickly multiply your real estate portfolio this way, especially in a place like Toronto, where property values have been increasing by more than 5% a year for a long time now. And with interest rates at an all-time low, you really couldn't ask for a better time to borrow and build wealth.”