How to Use a HELOC to Finance Real Estate Investments
THE SECRET TO INVESTING IN REAL ESTATE
When it comes to investing in real estate, it’s not chump change you’re dealing with. You need thousands of dollars saved up for that first investment. Your cash to close includes the inspection costs, down payment, closing costs to cover fees, and pre-paid taxes and insurance. Most of these are a rate of the purchase price and, therefore, vary in size.
So how am I doing it? Through trial and error at the beginning. I’m just starting to get my stride, and it has taken a couple of years. At first, I thought it was all about saving every penny so that you can buy that next investment property. The secret that I’ve found, though, is that to build wealth, sometimes you have to spend your money.
Take, for instance, my duplex. I reinvested money into the property to be able to pull out more money from the property. An interesting way of thinking about it, am I right? By putting in a little over $11,000 into cosmetic improvements and timing the market right, I was able to get the property reappraised for almost $100,000 more than I bought it for. This helped me reduce my monthly mortgage payments by $300/month and allowed me to take out a HELOC for $35,000. By doing this, I increased my investment by 3x and was able to take on a new project that would continue to help me build my real estate portfolio.
WHAT IS A HELOC?
A HELOC stands for home equity line of credit. It is a consumer loan that leverages the equity you have in a real estate investment. By using a HELOC, you, as a property owner, can borrow against the equity you have in a property through the use of a second mortgage. You can use this type of loan to take on projects, investments, consolidate debt, or a number of other things. The kicker? The size of your HELOC is based on the amount of equity that you have in your home or property.
Take, for instance, my multi-family property. I have a $35,000 HELOC on that property. Why isn’t it bigger? When I first bought my duplex, I only put 3.5% down. After making cosmetic updates to my duplex and watching the appraised values of real estate go up over the years, I had my property reappraised to switch from an FHA loan to a conventional loan, which would ultimately allow me to drop my principal mortgage insurance (PMI). The extra equity, in principle, that had been paid off (or, in this case, appraised higher) could then be applied towards a HELOC.
ESTIMATE THE AMOUNT OF YOUR HELOC
Like all loans, each bank has different rules and regulations when it comes to financing. Therefore their HELOC offering may look a bit different. Ultimately, lenders are going to allow you to borrow a specific percentage of the equity of your property. To estimate what that number would be, all you need to do is take your appraised value/purchase price and subtract your loan balance.
Example: $525,000 (re-appraised value) - $410,000 (loan balance) = $115,000 (equity)
From there, you would multiply the percentage that they are willing to loan you on the equity of your home. This then becomes your second mortgage. I would suggest you speak to your loan officer/mortgage lender for a HELOC referral, as well as do a bit of research yourself. This way you do not limit your options and are able to maximize the size of your HELOC.
IS IT SMART TO USE A HELOC TO INVEST?
The great thing about a HELOC is that you never have to touch it. It can be there in case you need it in the future, just as a safety net, or leveraged for a specific purpose like a wedding. I personally put a HELOC in place during the spring of 2020 because I was concerned about the housing market and making an income. By using my duplex as an asset, I was able to secure a line of credit through the use of a HELOC as a backup. Fast forward to 2021, and this HELOC will most likely be used to cover some of my project expenses.
Another reason I love HELOCs is that they typically are offered with relatively similar interest rates to home loans with little to no closing costs. This line of credit interest rate tends to be lower than personal loans and can be very beneficial when needing some quick cash for a renovation (or two). There is generally no pre-payment penalty if you are able to pay back the money early, and it can be used over and over (as long as the funds have been replenished). On top of that, untapped funds incur no interest charges.
The easiest way to think about a HELOC is like a credit card. You can borrow money from it, pay it off, and then borrow money from it again. You have a limit, and you have to pay interest on the funds you’ve borrowed or used. The benefit though is credit cards tend to have double digit interest rates, while HELOC’s right now (July 2021) can be secured for between 3%-5%.
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USING A HELOC TO BUY RENTAL PROPERTY
Similar to a HELOC, you can also decide to do a cash-out refinance on your home to leverage the equity you have built up. This one is a bit different for a few reasons, though.
Check in to ensure the mortgage interest rate being offered today is less than what you currently have in your home. If the interest rate is higher, it might be better to do a HELOC and leave your rate alone instead of locking in a higher rate.
Pay attention to is what percent of equity do you have in your property currently? If the difference between the market value and outstanding balance is showing greater than 20% equity having been paid off or accrued, you should be good to go! Generally speaking, cash-out refinances aren't as beneficial to use if you dip below 20% because you would then incur mortgage insurance on your monthly payments. This isn't always a bad thing, depending on what you are leveraging the money for, so just be sure to chat with a provider about your options and what it could impact.
With a cash out refinance you would incur some "closing fees". Be sure to touch base with your mortgage lender or a banker to get a better understanding of what this would cost and then determine next steps if its right for you!
IS IT A GOOD IDEA TO USE A HELOC AS A DOWN PAYMENT?
I personally will be using a HELOC to help me purchase my next investment property and I will use the monthly income from that property to pay off the HELOC each month. It's a great tool that can help you build a real estate portfolio quicker than you would be able to do otherwise. Think about it, you are sitting on equity in your home that you typically don't touch. The only way you see that equity is if you sell the home, but instead of selling, a HELOC allows you to leverage the capital you've either put into the home or that it's built over time. It's an amazing opportunity to take advantage of, no matter what your goal may be.
USING A HELOC TO BUY AN INVESTMENT PROPERTY
A HELOC is a great way to leverage equity in your current property to buy or pay down anything you would like. Whether it is buying land, buying a second home, or buying an investment property, you can take out a HELOC and use it to your liking. A quick reminder: you need to get an appraisal scheduled on your current property (if you didn't just buy it) to determine the "market value" This can take a few weeks, so be sure to plan ahead if you would like to leverage a HELOC for a down payment of any kind.
Once you have your appraisal back, you can "interview" different local banks to see what percentage of your equity they allow you to borrow against and at what interest rate they would charge for the loan. Typically, it is an interest-only loan that needs to be paid on a monthly basis. Depending on how big of a HELOC you receive, this gives you more wiggle room and flexibility for determining a payment plan,
WHAT’S THE CATCH WITH A HELOC?
There isn’t one! If you ask me, I think everyone should have a HELOC on their property if they are able to. You never have to use it, and it doesn’t count “against you” for having it. This is a great way to build out loan strategies for yourself and your investments.
All in all, I highly recommend you chat with a bank and look into securing a HELOC. And…if you need to buy a home first before being able to secure a HELOC, you know where to find me.
For more on maximizing your real estate investments, check out my Investment Property Tax Playbook- the strategies in it will save you THOUSANDS!
Cheers!
Jen
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