Financial Goals

Apache is functioning normally

Home equity is one of the main benefits of owning a home. Renting puts money into a landlord’s pocket, but owning a home helps you increase the value of your investment over time. When you do build home equity, it opens up cash-out options that can be used for home improvements, education expenses, paying off debt or other projects.

How can you tap into this valuable equity and turn it into cash? Typically you can access equity through a second mortgage, such as a home equity line of credit (HELOC) or a one-time home equity loan, or by using an alternative option like a cash-out refinance.

Let’s take a look at what a HELOC is, how it works and how it differs from other products that allow you to take advantage of the equity you’ve built in your home, like a home equity loan or cash-out refinancing.

What Is a Home Equity Line of Credit (HELOC)?

A home equity line of credit allows you to take out funds based on your home equity and pay it back with a variable interest rate. You can think about it as a credit card: Homeowners have access to a credit line that they can take from and pay back while using their home equity as collateral if they’re unable to make payments. Essentially, HELOCs enable homeowners to borrow against their own home equity.

Generally speaking, HELOCs have lower interest rates compared to similar options, like home equity loans or personal loans. That said, because HELOCs use variable rates, the interest rate will change based on certain benchmark rates and the current market. This, along with the amount of money you’ve spent using the line of credit, will determine your payments.

Although Pennymac does not currently offer HELOCs, we are available to answer any questions you have about how they work or what your other options are. Don’t hesitate to get professional advice. Contact a Pennymac Loan Expert to determine just what you should be doing with your home equity.

How to Qualify for a HELOC

To qualify for a HELOC, you will need a sufficient amount of equity in your home, a good credit score and low debt-to-income (DTI) ratio. Here are some tips to help you start the HELOC process and increase your qualification chances.

Start Building Home Equity

Since you usually need at least 15-20% home equity to qualify for a home equity line of credit, start prioritizing increasing the value of your home. You can build your equity by making slightly larger payments on your principal balance for your current mortgage. You can also consider refinancing your existing mortgage into a shorter-term mortgage.

Know Your Credit Score and History

Your credit score affects your eligibility for a HELOC, similar to when you were a first-time homebuyer applying for a mortgage. Most lenders require a credit score between 580 and 620, although that is ultimately dependent on the type of loan you choose and other qualifying factors.

Decide Why You Need the Funds

You don’t want to be casual with your HELOC spending, so be specific and intentional with borrowing by having a plan in place. While you may use a HELOC to have flexible on-hand funds, that doesn’t mean you should be careless. Set boundaries from the beginning on what you can and can’t spend these funds on, how often you want to make payments, etc.

People often use a HELOC to pay for home renovations, debt consolidation, education and special events, like weddings.

Do Your Research

Talk to multiple lenders, compare rates and benefits and read reviews. Look for a credible lender who is upfront about fees, timelines and other expectations. When deciding who to work with, it’s important to carefully evaluate the HELOC’s fees and terms and the lender’s reputation.

You’ll also want to know the following:

  • The length of the draw period, i.e., how long you’ll be able to access the funds
  • The period of time you’ll have to pay the remaining balance after the draw period ends. Sometimes terms can be 15 years and you may have a steep payment.
  • Is the interest rate fixed once you can no longer access the credit line

Understand Typical Contracts and Look for Fees

Understand the terms of your HELOC agreement. Are there prepayment penalties that prevent you from paying off more of your credit during the draw period? Is there a minimum amount you have to take out, and does it make sense to take out that much with your financial goals? Are there annual fees? What about application fees? Make sure you know the overall cost before signing a contract.

Know Your Debt-to-Income Ratio (DTI)

The debt-to-income ratio is the percentage of your monthly income that goes toward your current debt. Keep in mind that you can only have so much debt before lenders no longer consider you eligible. Paying off debt is a good way to show lenders that you know how to manage your money. Having too much debt, especially compared to your income, will indicate to lenders that you can’t sustain a line of credit with interest. Lenders typically look for your DTI ratio to be less than 43-47%. Reach out to a licensed loan officer who can help you figure out where you stand.

What Can You Use a HELOC For?

Essentially, homeowners can use a HELOC for whatever they need to, though it’s not wise to use these funds for nonessentials or day-to-day expenses. HELOC funds are best used for the following:

  • Home improvement. Home improvement is one of the best uses of HELOC funds. From renovations to additions, projects that increase the value of your home also help contribute to your home equity. Plus, there are potential tax deductions for certain home improvement projects.
  • Emergency funds. If you find yourself without a job or facing other emergencies, HELOCs are a good source of revolving funds that can be carefully managed, even in the draw period. Because interest doesn’t accrue on unused funds, you can use and pay off only what you need.
  • Debt consolidation. Though you should be careful not to generate more unnecessary debt, you can use a home equity line of credit to consolidate current credit card debt. Instead of dealing with high-cost credit card loans, you switch to a low-cost line of credit.
  • Medical bills. Medical bills can add up quickly, especially for unexpected or ongoing health concerns. People often take advantage of the low cost and low interest rates of HELOCs for these types of health expenses.
  • Education costs. Some people also use a home equity line of credit to pay off student loans or pay for tuition, especially because HELOC interest rates can be lower than student loan interest rates.

How Much Can You Borrow?

Even if you have substantial home equity, most lenders only allow you to take out some of what your home equity is worth.

Typically, you can use up to 85% of your home equity value, though it could be less depending on your financial history and other personal qualifications. Factors that influence your overall eligibility, how much you can borrow and the interest rate you may qualify for include:

  • Credit score and credit history
  • Current debt
  • How much home equity you have
  • Reliable income
  • Payment history

How to Pay Back a HELOC

A home equity line of credit is paid back with interest on whatever you take out of your revolving funds. However, HELOCs have a unique two-phase repayment method. These two phases are the draw and repayment periods, though the names can be misleading since you will make payments during both periods.

Phase 1: The Draw Period

The first phase is the draw period. This is when the credit line is open and your funds are available to use.

During the draw period, you can borrow funds as needed and only have to make minimum payments, or sometimes even interest-only payments for what you have borrowed. However, funds aren’t limitless; they’re revolving. If you hit the limit of available funds, you’ll need to pay back some of the money before you can continue borrowing.

The draw period is usually between 5 and 15 years. Some borrowers, like investors, commonly take out the maximum amount of funds and pay it off several times over. More commonly for homeowners, HELOCs can just be paid in minimum payments. Any other payments made on the principal loan during this time will lessen the amount you have to pay back during the repayment period.

Phase 2: The Repayment Period

Once your draw period is over, the repayment period begins when you must make recurring monthly payments. You also can’t take anything more, as access to the home equity line is closed. Payments will vary depending on whether or not you paid any interest during the draw period and how long each period is. Since most HELOC loans use variable interest rates, how the rate changes also affects payments.

Minimum payments may become significantly larger if you choose interest-only payments, so even if you have an interest-only payment option during the draw period, consider both the current and future financial consequences. These two periods aren’t necessarily split evenly, either; a 30-year HELOC loan is common, with a 10-year draw period and a 20-year repayment period.

It’s important to know when your draw period ends and when your repayment period begins so you can properly prepare. If you aren’t prepared to adjust financially, it’s tempting (or necessary) to open other lines of credit to pay what you owe on the HELOC, which can bury you in debt. It’s also possible to refinance if you aren’t ready to or don’t want to enter the repayment period when it arrives.

Pros and Cons of a Home Equity Line of Credit

HELOCs are a great way to put the money sitting in your home to work, but there are both pros and cons that homeowners should be aware of. Not every scenario calls for a HELOC loan, so consider the following benefits and drawbacks.

Advantages of a HELOC

  • Lower upfront costs. Compared to home equity loans, HELOCs tend to have lower upfront costs, which may help a homeowner decide what type of cash-out option they prefer.
  • Low or no closing costs. There are typically no closing costs for HELOCs. If there are closing costs, they are very low.
  • Lower interest rates. Traditional credit cards tend to have higher interest rate fees, but HELOCs generally offer lower interest rates. This makes consolidating debt a bit easier.
  • Interest is charged sparingly. Interest accrues only on funds that you actually use. You may have $200,000 available, but if you’ve only used $20,000, interest is applied just to that 10% utilized.
  • Flexibility. Because you don’t have to pay interest on more than what you’ve taken out, homeowners have much more flexibility and opportunity with their spending. You’ll have affordable funding options if something unexpected pops up or a project costs more than anticipated. You can use it for what you need, even for education.
  • Tax deductions. In some instances, the government allows homeowners with HELOCs a tax deduction for interest payments. Please consult your tax advisor regarding the tax benefits of HELOCs.

Disadvantages of a HELOC

  • Minimum draws. Some lenders require you to use a certain amount of the equity funds for their own benefit. Even if you end up not needing the minimum, you still have to take out and pay back (with interest) that money. Most lenders also charge an inactivity fee if the account isn’t being used.
  • Upfront costs. Though lower cost than other loans, HELOCs may still require application fees, home appraisal costs and other procedures. Consider the upfront expenses and determine if they’re worth the funds you would have access to.
  • Variable interest rates. Variable rates can go up and down depending on the market and federal lending rate, which can affect your monthly HELOC payments. When they are low, it’s great for borrowers, but high-interest rates can take a toll.
  • Fees. Without properly vetting a lender, you may find yourself stuck with unexpected or overwhelming fees such as cancellation fees, application fees, annual fees and prepayment penalties.
  • Potential credit damage. If you are unable to make payments, as with any loan, your credit score will take a hit.
  • Risking your home. Remember, your home is the collateral. If a homeowner mismanages their funds, misses payments and ultimately defaults when the repayment period rolls around, they could lose their home.
  • Attraction to nonessentials. Having large amounts of available funds can be freeing, but some homeowners struggle to use their funds only for essential or intentional spending, which can lead to greater debt that’s harder to pay off. HELOCs are not meant for day-to-day expenses like a regular credit card.

The Difference Between a Home Equity Loan and Line of Credit

HELOCs and home equity loans are similar in that they are both loans that use the value of your house as collateral and tend to have lower interest rates. However, there are some key differences.

What Is a Home Equity Loan?

A home equity loan is a form of consumer debt that allows you to borrow money against your home’s equity. The loan is paid separately in addition to your first mortgage which is why a home equity loan is often called a “second mortgage.” The following are some of the main differences between a home equity loan and a HELOC.

Lump sum payment. Home equity loans aren’t a revolving source of funds like HELOCs are. Instead, homeowners still use their home equity funds, but are given the money as a one-time lump sum.

Fixed interest rate. Unlike a home equity line of credit, home equity loans usually come with fixed interest rates. A fixed interest rate also means a fixed payment — you’ll know exactly what you are going to pay every month regardless of what’s going on in the market.

Prepaid interest costs and closing costs. With a home equity loan, you may have prepaid interest costs that you’ll have to sometimes pay at closing time. You also usually have to pay 2-5% of the loan amount in closing costs, whereas a home equity line of credit doesn’t often have closing costs.

Home equity loans are often used when borrowers need a big sum of cash for a one-time expense. If you need more flexibility, a HELOC loan lets you acquire funds as needed. If you know exactly what you need the money for and prefer fixed payments, a home equity loan is probably best.

HELOC Alternative: Cash-Out Refinancing

HELOCs are flexible and offer a lot of freedom, but they aren’t for everyone. If homeowners don’t want to take out a second mortgage, there are other options like cash-out refinancing.

What Is Cash-Out Refinancing?

A cash-out refinance is a new “first” mortgage that replaces your original mortgage with a new one through refinancing. Unlike the original, a cash-out refinance allows homeowners to borrow cash that they can use as needed. The new mortgage loan will be higher than the old one, and the difference between the loan amounts is distributed directly to the homeowner.

Cash-out refinancing allows you to maintain just one mortgage rather than two while still getting the immediate cash you need. These also offer fixed rates, which some people prefer for consistency.

How do you decide between a cash-out refinance and a HELOC? Determine whether you’d like to replace your current mortgage to get the cash you want (cash-out refinance) or add a second mortgage to get that cash (HELOC). For help understanding which could be the best fit for your needs, talk to a Pennymac loan expert.

HELOC Rates

Most often, the interest rate on a HELOC is variable. Variable rates come with pros and cons, and they are largely dependent on the current market and economy. Your eligibility will also affect the kind of rate you qualify for. Rates usually start lower at the beginning of the loan, or in this case, at the beginning of the draw period.

However, the rates will change based on benchmark interest rates, which can lower or raise your payments in both HELOC phases. Still, many lenders offer caps so that your interest rate won’t exceed a certain percentage. This is especially important to look for in a contract and consider as you’re trying to decide on a lender or on applying for a HELOC.

Also consider that HELOCs are a type of second mortgage, and generally speaking, rates for second mortgages are higher because the lender is taking on more risk.

HELOC FAQs

Here are some of the common questions many homeowners have regarding home equity lines of credit.

How Does Home Equity Work?

Many people want their home equity to work for them instead of being stagnant. That’s why HELOCs, home equity loans and cash-out refinance options exist. Homeowners should understand that though home equity refinancing can be helpful, you’re putting your home at risk if you aren’t properly prepared for the payments. Done correctly, though, home equity can be a great alternative source of funds and debt management.

How Can You Use Your Home Equity?

You can use your home equity loan for all sorts of reasons, as long as the lender hasn’t set certain limitations. Some lenders do limit what the line of credit can be used for, so it’s always best to discuss such limitations with lenders before signing anything. Also remember that funds shouldn’t be used for nonessentials or like a traditional credit card. Most often, people use HELOC loans to add value to their home through home improvement, to pay off extensive bills or expenses or to consolidate their current debt to get a better rate and lower costs.

Can You Pay Off a HELOC Early?

As long as the lender sets no prepayment penalties, you should be able to pay off a HELOC early, even in the draw period. The more you pay off during the draw period, the less you’ll have to spend during repayment. If, for example, the variable interest rate is relatively low during the draw period, you could pay the interest plus a little extra on the principal balance. Again, some lenders will penalize you for paying more than the required minimums, so learn about the lender’s prepayment policies.

How Long Does the Closing Process Take for a HELOC?

Closing a home equity line of credit usually takes 1-2 weeks. However, it can take up to 4 weeks to get everything settled, and even after that, you may have to wait several days or weeks before accessing the available funds. It all depends on the appraisal process, documentation timeline and the lender’s underwriting process.

What’s the Difference Between a HELOC and a Home Improvement Loan?

The main difference between a HELOC and a home improvement loan is how you receive the funds. HELOCs allow borrowers to take out smaller amounts of money depending on how home projects change and evolve. Home improvement loans are also limited to specific home projects, whereas HELOCs can be used outside the home for any purpose.

Is a HELOC Right for You?

A home equity line of credit can be a great solution for established homeowners who need more flexible spending options. If funds are used carefully, for the right reasons and through a reliable lender, borrowing against your home equity is a viable option for many.

However, a home equity loan may be a better option if you could benefit from a lump sum of immediate funds and prefer fixed interest rates and predictable monthly payments. To learn more about turning your home equity into cash in hand, speak with a Pennymac loan expert today.

Share

Categories

home equity renovations loan types refinance

Source: pennymac.com

Apache is functioning normally

Apache is functioning normally

Robo-advisors are becoming increasingly popular, giving everyday people a more cost-effective way to invest at all levels.

Rather than pouring over investment books and blogs, you can choose a robo-advisor that fits with your general risk philosophy, then pay a small percentage of whatever funds you’re able to invest.

You presumably get the returns without having to worry about the daily maintenance of your investments.

FutureAdvisor: Personalized Investment Advice

FutureAdvisor is a relatively new standout in the industry, offering personalized investment advice to help you reach your financial goals. And while touted as a robo-advisor, FutureAdvisor has a real-life team of human investors helping to manage client portfolios. Their investment strategy focuses on the long-term and is based on academic research and historical performance.

This is also a great choice for those who are wary of fintech startups because all FutureAdvisor accounts are held through Fidelity. You get the security of major financial institutions with the technology of a data-driven startup.

You can also take advantage of certain free services with FutureAdvisor. Keep reading to find out more about how you can invest with FutureAdvisor.

How FutureAdvisor Works

To get started with FutureAdvisor, you’ll need at least $10,000 to invest. Right off the bat that can be limiting to some, but they do collectively manage over $900 million at this point. Once you’re ready to start, you can get a free portfolio analysis.

You can link all of your accounts to FutureAdvisor, which then reviews all of your information. Additionally, you’ll add in your financial goals along with your target timeframe. From there, you’ll receive customized recommendations based on modern portfolio theory.

It’s a comprehensive way to figure out how to stay on track throughout your financial journey, especially since it’s looking at all of your actual information. Once you’ve taken advantage of this free service, you can then choose to sign up to have your funds managed through a FutureAdvisor Premium account. This will give you access to a team of financial advisors.

Supported Investments

Investments they support include IRAs (traditional, Roth, and SEP) as well as individual and joint taxable accounts. There are only two basic requirements: you must start with at least $10,000 and you have to be between 18 and 68 years old.

This is another place where things differ from your typical robo-advisor. You keep your money with a major brokerage, like Fidelity. FutureAdvisor then manages your funds as a fiduciary.

Tracking Retirement Savings

Want to track your retirement savings?

Log onto your FutureAdvisor dashboard any time of the day to view your total assets. You’ll be able to see exactly how your assets are being managed, which is based on various factors, including:

  • Your age
  • Risk tolerance
  • Portfolio size and holdings
  • How long you have until retirement

You’ll also receive your “best path” to retirement, along with suggested steps and best practices you can take to optimize your investments.

FutureAdvisor Fees

There are three parts to FutureAdvisor’s fee structure. The first is an annual management fee of 0.50%, which is charged in increments on a quarterly basis. The management fee is charged on the number of assets that FutureAdvisor actually manages.

The next fee is the expense ratio for any funds you’re invested in, like ETFs. ETF expense ratios average around 0.15%. Finally, you’ll be charged a commission anytime a trade is made. It may seem like a lot, but FutureAdvisor manages your investments based on the size of your portfolio. Additionally, FutureAdvisor uses several fee-free funds to save you money.

In total, most accounts average an annual fee of 0.65% on the assets you have managed by FutureAdvisor.

When you’re getting started, you won’t be charged anything if your accounts are already held by Fidelity. It’s also free to transfer accounts from Vanguard. However, most other brokerages and mutual fund companies will charge a transfer fee, ranging between $50 and $100 per account.

It’s also worth noting that there are no fees to cancel your account with them. Since your money is held in a Fidelity account, they simply take themselves off as the account manager and you have control to do whatever you want with the funds. Fees may apply if you want to close your account with Fidelity.

Special Features

Whether you just want some free retirement advice or a Premium account to grow your investments, FutureAdvisor has plenty to offer investors of all types. Even if you don’t meet the $10,000 minimum balance, there are services you can take advantage of. And if you do decide to have FutureAdvisor manage your accounts, you’ll be happy to know about some of their best features.

Free Advice

We already talked about the free portfolio analysis you can receive from FutureAdvisor, which is a great perk in itself. However, even if you don’t want to sign up for an account and upload your investment information, there are still tons of amazing resources you can take advantage of.

Are you totally new to retirement planning and investing?

FutureAdvisor’s Investing Library

Navigate over to FutureAdvisor’s Investing Library and you’ll find countless guides and articles. If you’re not sure where to begin, pick an overview topic like “How to Start Investing.” There are also guides on how to invest different amounts, like $10,000 or even $500,000 — so no matter what you have, you receive holistic advice about how to effectively manage your savings.

There are also really specific topics, so if you’re looking for a particular how-to guide about something investment-related, you’re likely to find it here. For example, you can read step-by-step on how to open an IRA or dive deeper into the best ways to diversify your portfolio.

FutureAdvisor also has a section of its website devoted to reaching your goals. In addition to direct investment advice, they also talk about things like the cost of housing and healthcare — both of which are extremely relevant in retirement planning. On top of that, they offer 401(k) and529 college savings plan assistance.

FutureAdvisor’s Algorithm

Interested in how FutureAdvisor determines its investment strategy?

Check out “Inside the Algorithm,” which is loaded with super-specific articles on their automatic rebalancing strategy, tax-efficiency tactics, stock and bond splits, and more. Again, you don’t even have to create a free account to take advantage of this resource library.

It’s completely available to anyone, and it’s smart to look at before you choose FutureAdvisor for your investments. And the blog is updated regularly so you always know about the company’s latest updates.

Tax-efficient Strategies

FutureAdvisor utilizes a few different strategies to minimize your tax liability. Like most robo-advisors, they’ve integrated automatic tax-loss harvesting to all accounts. It’s particularly helpful, however, if you’re in a higher tax bracket.

So what exactly is tax-loss harvesting?

The process can be quite technical, but basically, tax-loss harvesting involves selling a security that’s had a loss. It’s then replaced with a similar position so that your portfolio is right where it should be. But since you sold the original security at a loss, that amount is used to offset your taxes on both your income and capital gains.

Of course, there are all kinds of rules regulating tax-loss harvesting, which is why it’s helpful to have an automated expert like FutureAdvisor monitoring and executing the process for you.

FutureAdvisor also engages in other tax-efficient strategies. When charging your annual fee, they take this money out of your taxable accounts like a traditional IRA, rather than out of a tax-advantaged account, like a rollover IRA. Over time, that can save you money on the amount of taxable income you have.

Capital Gains and Tax Policy

The company adheres to its own Capital Gains and Tax Policy to help clients save as much as possible on their tax burden. In fact, when you sign up for investment management with FutureAdvisor’s Premium service, you can actually see what your projected tax impact will be before they rebalance your portfolio.

Plus, they continually review your short-term and long-term holdings to best balance your portfolio on a regular basis. Just as they do with all their decisions, FutureAdvisor consistently rebalances your portfolio based on your specific situation.

You can expect your portfolio to be rebalanced between four and six times each year. This is the average amount it takes to maintain your target asset allocation to make sure your investments are staying on track.

Fidelity Integration

Unlike most other robo-advisors, FutureAdvisor doesn’t actually hold your money. Instead, they’ve carved out an agreement with Fidelity. They serve as custodian of your investment accounts, but the money is still held by one of two national brokerages.

The great thing about this is that both options are SIPC insured. While that doesn’t protect your investments against market losses, it does offer certain protections if the brokerage closes for some reason.

Fee-Free ETFs

Working with Fidelity also means that FutureAdvisor can help you save money by using fee-free or low-cost ETFs.

Fidelity is just shy of that with 91 fee-free ETFs to choose from. Since you pay both an annual management fee and trade commissions with FutureAdvisor, this can really help you save money while optimizing your portfolio.

The partnership between FutureAdvisor and these two brokerages also gives you flexibility. If you change your mind and don’t want to pay for the Premium service anymore, you simply remove FutureAdvisor as the account custodian. Then you still have your money invested in Fidelity and you don’t have to worry about paying any transfer fees or closing fees.

Is FutureAdvisor right for you?

People who currently have investment accounts with Fidelity are automatic candidates for FutureAdvisor, especially if you’ve been considering using a robo-advisor.

If your funds are already housed within one of these two brokerages, it’s extremely simple to get started. And if you decide you don’t like how your funds are managed, you simply remove FutureAdvisor as your custodian and move on — without paying any fees.

Give FutureAdvisor a Test Drive

Really, anyone can test drive FutureAdvisor by signing up for the free analysis and recommendations. You’ll even get reminders about how and when to rebalance your portfolio, you’ll just have to manually do it yourself. Once you’re comfortable with how your investments look, you may decide to sign up for the Premium account so you can invest on autopilot.

Even with these perks, FutureAdvisor’s fees are a bit higher compared to those of other robo-advisors. If cost is your bottom line, you may want to explore other options. But the upside is that your funds are actually kept with extremely reputable brokerages, making FutureAdvisor an interesting hybrid between a traditional financial advisor and fintechs.

Ultimately, your investments should be based on your personal values and strategies. If these align with FutureAdvisor, it’s definitely worth giving them a try, especially if you start with a free account.

Source: crediful.com

Apache is functioning normally

Apache is functioning normally

Many people are lured into the world of real estate investing by stories of millionaires who started their journey with no money down or no steady employment. But the reality is that making money in real estate isn’t easy; a good credit score, investment capital and steady income can help in the beginning.

You’ll also need to grasp the nuances of the local real estate market and learn how to manage financial aspects such as cash flow and property taxes. While real estate buying, selling, and renting may not be much like a game of Monopoly, it is possible to earn steady side income, supplement your retirement, or even build a full-time real estate investment business with the right tools, knowledge, and patience.

Unlike mutual funds, the stock market, cryptocurrency or many other investments, real estate is tangible. Real estate is a concrete asset—one can see, touch, and even reside in. That gives investors a sense of security. However, it also creates unique challenges.

Managed well, the stability and passive income from rental properties can be a safety net against more volatile investments.

This guide is here to clarify the process for beginners. It aims to empower you to make informed decisions, reduce risks, and lay a strong foundation for your real estate investing journey.

Benefits of Investing in Real Estate

The allure of real estate goes beyond the mere ownership of tangible assets. It presents a robust suite of financial benefits that have the potential to amplify wealth and provide stability in uncertain times. As we navigate the advantages, it becomes evident why many seasoned investors prioritize real estate in their portfolios.

Steady and Passive Income

Real estate investing, especially in rental properties, stands out for its potential to provide a consistent revenue stream. When you own a rental property, the monthly or quarterly distributions from tenants contribute to steady income, which can safeguard your finances against unexpected events or economic downturns.

This consistency contrasts with the often erratic nature of the stock market, which can fluctuate daily based on global events, company performances, and other factors. Additionally, for those aiming to attain financial freedom, the passive income generated from real estate can be a step closer to achieving that goal. Over time, as the mortgage payment decreases or remains static, rental rates may rise, increasing your monthly cash flow.

Appreciation Potential

Every investor dreams of their assets appreciating, and real estate often doesn’t disappoint. While there can be periodic downturns in the real estate market, historical trends suggest that properties generally gain value over the long run.

This means that not only can investors benefit from rental income, but they can also potentially see substantial gains when they choose to sell the property.

Tax Benefits

Navigating the world of taxes can be intricate, but real estate investors often find several advantages here. The ability to deduct mortgage interest and property taxes from taxable income can be a significant financial boon.

Furthermore, strategies like depreciation allow real estate investors to offset rental income, reducing their tax burden. Consulting with a financial advisor can help investors maximize these benefits and understand other potential tax advantages, such as 1031 exchanges or deductions related to property management.

Diversification

The saying “don’t put all your eggs in one basket” is sound investment advice. Diversification is a fundamental strategy to mitigate risks. By adding real estate to an investment portfolio, investors introduce a separate asset class that doesn’t directly correlate with the stock market or mutual funds. This can provide a buffer, ensuring that a downturn in one sector doesn’t wholly derail an investor’s financial trajectory.

Leverage

Leverage, in the context of real estate investing, refers to the ability to use borrowed capital to increase the potential return on an investment. When you purchase property with a mortgage loan, you’re often putting down only a fraction of the property’s total cost, while still reaping the benefits of its entire value in terms of appreciation and rental income.

This magnifies the return on investment, as the gains and income generated are based on the property’s total value, not just the down payment. It’s a powerful tool but should be used wisely. Over-leveraging or not accounting for potential rental vacancies can turn leverage into a double-edged sword.

Types of Real Estate Investments

As one dives deeper into the world of real estate, it becomes evident that this asset class is multifaceted, with various avenues to explore and invest in. The right choice often depends on an investor’s goals, risk tolerance, budget, and expertise. Here’s a closer look at some prominent types of real estate investments:

Residential Properties

Residential properties cater to individuals or families. They range from single-family homes to duplexes, triplexes, high-rise buildings with apartments, and other multi-unit properties. You may encounter the term “MDU” or “MUD,” which stand for multi-dwelling unit or multi-unit dwelling, to describe anything more than a single family home, or SFR (single family real estate).

Investing in residential real estate, especially the SFR market, is often a beginner’s first step due to its familiarity and the perpetual demand for housing. While these properties can be a reliable source of rental income, investors should be prepared for the challenges tied to property management, tenant turnover, and ongoing maintenance.

Commercial Real Estate

When one thinks of skyscrapers lining city horizons or sprawling office parks in suburban locales, that’s commercial real estate. These properties are tailored to businesses, and can include complete corporate headquarters or individual offices.

Commercial leases often run longer than residential ones, offering the potential for stable, long-term rental income. However, the entry point can be higher, with larger down payments and a more extensive due diligence process. Additionally, commercial real estate values can be closely tied to the business environment of the locality.

Industrial

Industrial real estate encompasses properties like warehouses, distribution centers, and manufacturing facilities. They’re integral to business operations, ensuring products move efficiently from manufacturers to consumers.

Investing in this sector can offer substantial rental yields, especially if the property is strategically located near transportation hubs. However, the nuances of industrial real estate, such as zoning laws and environmental concerns, necessitate a more in-depth understanding than residential or commercial sectors.

Retail

This sector includes shopping malls, strip malls, and standalone stores. What’s unique about retail real estate is that leases sometimes include a provision where the landlord gets a percentage of the store’s profits, termed as “percentage rent.”

In a thriving commercial area, retail properties can be quite profitable, with long-term leases and the potential for appreciating property values. However, investors should be mindful of shifts in consumer behavior and the evolving retail landscape, especially with the rise of e-commerce.

Multi-Purpose Commercial

A new breed of commercial real estate has emerged to compete with the growth of e-commerce. Multi-purpose commercial spaces blend housing units with office space and retail, often adding hospitality and entertainment venues.

Typically, these spaces are the domain of large real estate investment and property management firms. But if you invest in commercial office space or retail, you will be competing with these multi-purpose properties for tenants, so they are worth acknowledging.

Real Estate Investment Trusts (REITs)

For those not keen on direct property ownership, REITs present an attractive alternative. These are companies that own, operate, or finance income-producing real estate across various sectors. What makes REITs distinctive is that they’re traded on stock exchanges, similar to stocks.

By investing in a REIT, you’re buying shares of a company that manages a portfolio of properties, thus gaining exposure to real estate without the hassles of property management. Moreover, by law, REITs are required to distribute at least 90% of their taxable income to shareholders, leading to potentially attractive dividend yields. However, it’s essential to remember that like all publicly traded entities, REITs can be subject to market volatility.

9 Ways to Invest in Real Estate

Investing in real estate can seem tricky for beginners. But, with time and patience, anyone can master it. Focus on simple investment methods first to get to know your local property scene, meet experienced investors, and learn how to handle money wisely. As you learn and grow, you can dive into more complex investment options.

Here are some great ways for beginners to start in real estate:

1. Wholesaling

Acting as the bridge between property sellers and eager buyers, this method primarily focuses on securing properties at a rate below the prevailing market value. The secured contract is then transferred to an interested buyer, ensuring a margin for the wholesaler.

2. Prehabbing

Unlike intensive property renovations, prehabbing is about amplifying a property’s appeal through minimalistic enhancements. These properties, once given their facelift, usually attract investors with a keen eye for larger renovation projects.

3. Purchasing Rental Properties

An avenue promising consistent returns, this involves acquiring properties to lease them out. For those not inclined towards the intricacies of landlord duties, there’s always the option of hiring seasoned property management professionals.

4. House Flipping

A strategy that has garnered significant attention, house flipping involves a cycle of purchasing, upgrading, and promptly reselling properties, aiming for a profit. The emphasis is on swift transactions and keen market acumen.

5. Real Estate Syndication

Envision a collective where like-minded investors come together, pooling both resources and expertise. Such collectives venture into large-scale property acquisitions, and the ensuing profits or rental incomes are distributed among the participants.

6. Real Estate Investment Groups (REIG)

Primarily, these are conglomerates that steer their operations around real estate investments. By amassing capital from a plethora of investors, they dive into acquisitions of sizeable multi-unit residences or commercial holdings.

7. Investing in REITs

Real Estate Investment Trusts (REITs) revolve around the ownership and meticulous management of properties that yield income. However, investors don’t have to handle the management themselves. Instead, participants can relish the benefits of the real estate sector without the responsibilities of direct property ownership.

8. Online Real Estate Platforms

A fusion of technology with real estate, these platforms seamlessly connect potential investors with vetted property developers. This synergy enables backers to finance promising property ventures and, in exchange, enjoy periodic returns that encompass interest.

9. House Hacking

A blend of homeownership and investment, house hacking is about maximizing the potential of a multi-unit property or a single-family home. Investors live in one segment while leasing out the remaining portions. This dual approach can significantly reduce or even negate monthly housing expenses, serving as an excellent introduction to the world of property management for novice investors.

6 Steps to Get Started in Real Estate Investing

Starting on the path of real estate investing requires careful planning, due diligence, and a methodical approach to ensure that your investments are sound and have the potential for fruitful returns. Whether you’re dreaming of becoming a millionaire real estate investor or merely looking to diversify your investment portfolio, following a structured process can be the key to success. Here’s a step-by-step breakdown:

1. Assess Your Financial Health

Every investment journey should begin with introspection. As an aspiring real estate investor, it’s essential to have a clear understanding of your current financial standing. Ask yourself questions like:

  • How much capital am I willing to invest?
  • What are my short-term and long-term financial goals?
  • Do I have an emergency fund set aside?

Evaluating your risk tolerance is equally crucial. Some might be comfortable flipping houses, while others might prefer the steadiness of rental properties. Consulting a financial advisor at this stage can provide insights tailored to your financial health, enabling you to make informed decisions as you proceed.

2. Dive Deep into Market Research

Knowledge is power in the world of real estate. The local market can be significantly different from national or even statewide trends. Delve deep into understanding:

  • The demand for rental properties in your target area.
  • The average property values and rental rates.
  • The historical appreciation rates.
  • Any upcoming infrastructure projects or urban development initiatives.

Furthermore, familiarize yourself with real estate terminology. Phrases like “cap rate,” “loan-to-value,” and “operating expenses” will become a regular part of your vocabulary. The better informed you are, the more confidently you can navigate your investments.

3. Assemble Your Real Estate Team

No investor is an island. Success in the real estate business often hinges on the strength and expertise of your team. Look for professionals with a proven track record and positive reviews. Your team might include:

  • Real estate agents who understand the investor’s perspective.
  • Property managers to streamline tenant interactions and maintenance.
  • Lawyers specializing in real estate transactions.
  • Accountants familiar with the tax implications of real estate investments.

4. Explore Financing Options

The path to acquiring a property is paved with various financing methods. Traditional mortgages are common, but the real estate industry offers other mechanisms like:

  • Hard money loans.
  • Private money loans.
  • Real estate syndication where multiple investors pool resources.
  • Seller financing.

Each of these has different pros and cons, interest rates, and repayment terms. Understand each deeply to determine which aligns best with your financial strategy.

5. Analyze Potential Properties

The crux of real estate investing is ensuring that the numbers make sense. Before purchasing, assess the property’s potential for generating rental income. Break down:

  • Monthly mortgage payments
  • Property taxes
  • Maintenance costs
  • Potential vacancy rates

Your goal should be a positive cash flow, where the monthly income from the property (rent) exceeds all these expenses.

6. Negotiate and Close the Deal

Once you’ve zeroed in on a property, the negotiation phase begins. Here, understanding the property’s market value, any existing damages or repair needs, and the local real estate market dynamics can give you an edge.

When it comes to closing, be aware of all associated costs. These might include inspection fees, title insurance, and escrow fees. Being well-informed can help you negotiate these fees and ensure that you’re not overpaying.

Risks and How to Mitigate Them

Like any investment, real estate comes with its set of challenges and uncertainties. The difference between successful real estate investors and those who falter is often the ability to anticipate risks and prepare for them. Here’s an exploration of some prevalent risks in real estate and actionable steps to manage them:

1. Market Fluctuations

Real estate markets can be volatile, with property values rising and falling based on a myriad of factors.

Mitigation: To protect against market downturns, it’s essential to buy properties below their market value. Conducting comprehensive research and seeking expert investment advice can help investors make informed decisions. Remember, real estate is often a long-term game, so a short-term dip can be offset by long-term appreciation.

2. Unexpected Repairs and Maintenance

Properties can often come with surprises, from plumbing issues to roof repairs.

Mitigation: Regular property inspections can catch potential problems before they become major expenses. Setting aside a buffer fund specifically for maintenance can also cushion the financial blow of unforeseen repairs.

3. Vacancy Periods

There might be periods where your property remains unoccupied, leading to loss of rental income.

Mitigation: Properly vetting and building a good relationship with tenants can lead to longer lease periods. Diversifying your investment properties across different areas can also help, as vacancy rates might vary from one location to another.

4. Legal and Tax Implications

Real estate investors can sometimes find themselves entangled in legal disputes or facing unexpected tax bills.

Mitigation: Regular consultations with a tax professional or attorney familiar with the real estate industry can keep investors informed and protected.

Long-term Strategy and Growth

Real estate investing is not just about making a quick buck; it’s about building lasting wealth. Adopting a long-term perspective and continuously refining your strategy can pave the way for consistent growth in the real estate industry. Here’s how:

1. Define Your Real Estate Identity

Are you more comfortable with a buy-and-hold strategy, where properties are retained for long-term growth and steady rental income? Or do you thrive on the excitement of flipping houses, where properties are bought, renovated, and sold for profit? Understanding your preference can help tailor your investment strategy.

2. Reinvestment is Key

For those adopting a buy-and-hold strategy, reinvesting the rental income can substantially grow your real estate portfolio. By channeling profits into purchasing additional properties, investors can benefit from compounded growth.

3. Diversify Your Portfolio

As you gain experience, consider diversifying across various real estate sectors. Branching out into commercial real estate or exploring real estate investment trusts (REITs) can provide additional avenues for income and growth.

4. Continue Your Education

The real estate industry is continually evolving. By staying updated on market trends, attending seminars, and networking with other real estate professionals, you can adapt your strategy and seize new opportunities as they arise.

5. Scale Strategically

A real estate empire begins with just one property. With time, dedication, and a sound strategy, it’s possible to grow your holdings into a substantial full-time income. As you scale, ensure you’re not overextending; always prioritize the quality of investments over quantity.

Key Tips for Beginners

Embarking on a journey into real estate investing can be thrilling, yet the complexities of the industry can sometimes overwhelm beginners. Simplifying the learning curve is essential for novice investors to make informed decisions and find success. Here are some pivotal tips to guide those just starting out:

1. Start Small and Scale Gradually

Many millionaire real estate investors began their journey with a modest property. Purchasing a smaller, more manageable property as your first investment can help you navigate the nuances of the real estate business without being overwhelmed. As you gain confidence and experience, you can then venture into bigger and more diverse properties to scale your portfolio.

2. Prioritize Education

The world of real estate is vast and ever-evolving. Leverage online real estate platforms to learn about market trends, investment strategies, and financing options. Additionally, joining real estate investment groups can be invaluable. These groups not only provide mentorship but also offer opportunities to share resources, insights, and deals with other investors.

3. Location is Crucial

In the real estate realm, location often takes precedence over the type or condition of a property. A mediocre house in a prime location can fetch better returns than a grand mansion in a less desirable area. Research local market dynamics, neighborhood amenities, future development plans, and other location-specific factors before making an investment decision.

4. Networking is Key

Surrounding yourself with knowledgeable people can fast-track your learning process. By connecting with seasoned real estate investors, you can gain insights from their experiences, avoid common pitfalls, and even discover potential partnership opportunities. Attend local real estate seminars, join investor forums online, and participate actively in real estate conferences to grow your network.

5. Stay Updated and Adapt

The real estate industry is not static. Market conditions, property values, and investment strategies can change. Being adaptable and staying updated on industry trends will ensure you remain ahead of the curve and can capitalize on new opportunities.

6. Always Conduct Due Diligence

Before diving into any real estate transaction, thorough due diligence is imperative. From understanding property taxes and zoning laws to estimating potential repair costs and evaluating tenant profiles, leaving no stone unturned will protect you from potential setbacks.

8 Terms Beginner Real Estate Investors Should Know

Venturing into real estate can feel like you’ve entered a world with its own language. Don’t worry; everyone feels this way at the start. Knowing basic real estate terms can help you communicate confidently and make informed decisions.

Dive into these essential terms every beginner should grasp:

Appreciation: Appreciation is the increase in the value of a property over time. It’s one of the primary ways real estate investors make money, especially in growing markets. Appreciation can result from factors like inflation, increased demand, or improvements made to the property.

Capitalization rate (cap rate): Think of the cap rate as a tool to gauge the potential return on a property. It’s a percentage derived from comparing a property’s net operating income to its current market price.

Cash flow: This term captures the money dance – what’s coming in and what’s going out. In the context of rental properties, it means the rental earnings minus all the costs. Positive cash flow indicates you’re earning more than you’re spending.

Equity: Equity represents the value of ownership in a property. It’s calculated by taking the market value of the property and subtracting any outstanding mortgage or loans against it. As an investor pays down their mortgage or if the property appreciates in value, their equity in the property increases. This equity can be tapped into for various financial needs or reinvested.

Leverage: This term refers to the concept of using borrowed money, often in the form of a mortgage, to invest in real estate. It allows investors to purchase properties with a small down payment and finance the remainder. When used correctly, leverage can amplify returns, but it can also increase the risk if property values decline.

Net operating income (NOI): Simplified, NOI is the profit made from a property after deducting all operational costs. It’s your rental income minus all the expenses, showing the true earning potential of a property.

Real estate owned (REO): An REO property is one that didn’t sell at a foreclosure auction and is now owned by the bank. These properties are often sold at a lower price because banks aim to sell them quickly, making them attractive to investors.

Return on investment (ROI): In simple terms, ROI measures the bang you get for your buck. It’s calculated by comparing the profit you made to the amount you invested. The higher the ROI, the better your investment performed.

Conclusion

Real estate investing offers an avenue to diversify your portfolio, generate steady income, and potentially achieve long-term growth. With due diligence, a clear strategy, and the right team, beginners can successfully navigate the complexities of the real estate industry and lay the foundation for a prosperous investment journey. Remember, every millionaire real estate investor started with their first property. Your journey is just beginning.

Source: crediful.com

Apache is functioning normally

Apache is functioning normally

After teaching my “Saving and Investing 101” class at the University of Rochester yesterday, two undergraduate students ask me personal investing questions:

  • “How should I invest the money in my Roth IRA?”
  • “My portfolio is currently in 7 stocks, all tech stocks. My dad thinks I should diversify. Should I? And how do I do that?”

I bet you’ve had similar questions before. Investing is a confusing topic.

Thankfully, many personal investing questions have a similar answer. So whenever anyone asks me for specific investing advice, I go over the following ideas.

It’s About *You*

Giving personalized investing advice can only occur after understanding the investor. One idea I shared with the class yesterday is:

“If 100 college students asked me how to invest their Roth IRAs, I know this: I would eventually tell most of them that a diversified stock portfolio is an ideal place to start. They’re young with long investing timelines, and the higher risk/reward aspect of stock investing makes sense for them.

But, some of those 100 students might need completely different advice based on their unique circumstances. Telling the whole group, “Invest in stocks,” would be a disservice to some individuals. That’s why personalized investing advice should come after – not before – understanding the individual investor.”  

Goals, Timelines, Risk Tolerance

How, then, do we determine the specific investing advice for individual investors? How do we “understand” or “get to know” them?

You need to understand their goals and risk tolerance.

A financial goal is a combination of an amount of money and a timeline for a specific purpose. E.g. “I need $1.5M by 2035, because that’s when I want to retire.” The amount and timeline provide concrete numbers from which we can do objective math.

Risk tolerance is a bit harder to pin down. It’s personal and emotional. To unwrap someone’s risk tolerance, it helps to ask questions about their investing past (“Have you lived through bear markets or crashes – how did it make you feel?”). Short of that, running through hypotheticals can help (“If your account dropped 30%, but you knew it would likely recover in ~3 years or less, how would you feel?”). There are also many risk tolerance quizzes and questionnaires on the internet.

The goals and timelines lead to a math-based, objective investment recommendation. Short-timelined money should be invested in low-risk, low-reward assets, and long-timelined money in high-risk, high-reward assets. This is the basis of “bucketing your money.” If (or when) your goals change, your investment allocation should change too.

Risk tolerance adds a subjective, psychology-based aspect to an investment recommendation. Perhaps the math alone points an investor toward an 80% stock, 10% bond, 10% alternatives portfolio. But if they’re incredibly risk averse, that 80% stock allocation will turn their brain to mush when a bear market hits. (Not if a bear market hits; when.) A more conservative allocation would help their mental health.

How conservative? It’s impossible for me to say. It depends (!!!) on the person. There’s a balance between the math (can you hit your goals on time?) and the psychology (will you be able to sleep along the way?).

The crux of investing is not creating a Scrooge McDuck pile of gold.

Instead, investing is about maximizing the odds of achieving your financial goals while minimizing your sleepless nights.

Back to the Students…

How should the first student invest her Roth IRA?

Assuming her Roth IRA money is purely for retirement**, I think an 80-100% diversified stock allocation makes sense. A total market index fund would be a good choice.

**Most IRAs are. Withdrawals before age 59.5 are penalized. They are retirement accounts.

How should the second student diversify away from her 7 tech stocks?

This one is more nuanced. First, the money is not in an IRA. It might have a short-term timeline associated with it. She and I discussed this. The money is all long-term.

From there, the same idea of an 80-100% diversified stock allocation makes sense.

But! This student might enjoy the fact that she owns those 7 tech stocks. Similarly, I enjoy the fact that I own Berkshire Hathaway – it’s the only non-fund investment I own, the only single stock.

If her stock ownership is important to her, I think it’s reasonable for her to keep <10% of her portfolio in those 7 stocks. The remaining >90% of her investable assets should be diversified.

Different people. Different situations. Different advice.

Thank you for reading! If you enjoyed this article, join 7000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.

-Jesse

Want to learn more about The Best Interest’s back story? Read here.

If you prefer to listen, check out The Best Interest Podcast.

Source: bestinterest.blog