Should i use part of a home equity loan to put a down payment on another house?

Question

Should i use part of a home equity loan to put a down payment on another house to rent out?

Nathan Gesner · Answer

Your equity is not a savings account from which you can withdraw for free. If you cash out equity in a property, you are "borrowing" that money from the lender. Upfront expenses and monthly payments must be considered when calculating the return on your investment.EXAMPLEYou cash out $100,000 of your equity and use this as a down payment on a $400,000 investment property. This creates two loan payments ($100,000 of equity and $300,000 on the new mortgage).

Key Numbers

• Home Equity Loan Interest Rate: 6%
• Mortgage Interest Rate: 7%
• Rental Income: $3,000 per month
• Expenses (management, taxes, insurance, maintenance): $800 per month

Income and Expenses

• Monthly Rental Income: $3,000
• Monthly Expenses: $800
• Monthly Mortgage Payment: $2,000

Explanation

• The investor earns $3,000 in rent each month.
• They pay $2,000 on the investment property mortgage and $800 on other expenses.
• This leaves $200 profit each month or $2,400 per year.
• However, you have to pay $6,000 interest on the equity borrowed.
• This leaves you with an annual loss of $3,600.

This example shows that while the rental property generates positive monthly income, the interest cost of borrowing the initial $100,000 results in an overall annual loss. The investor must consider whether the potential property value increase or other benefits outweigh this loss.

Sharon Sasser · Answer

Hi Rabia,

I didn't use a home equity loan, but instead chose to use a HELOC to purchase our duplex which is an LTR and our vacation rental on the Big Island. I like that the HELOC functioned more as a credit card, and I only had to pay for what I used, so I had 200K of equity on hand, but only had to pay the interest on 120K. This was in 2019 when I was funded so the terms were much more favorable than they are now. The interest rate was 4.5%. First 10 years is interest only, then after that you start paying principal/interest, but you can pay off the credit sooner and then as you pay it off you can invest in more deals once you get your other properties cash flowing to cover the debt service. In 2020 I took advantage of the low interest rates and got our primary home down to a 3.2% interest rate from its original 4.5% in 2013. I had to refinance/cashout to pay off the HELOC because the lender would not allow that debt/lien on our home which was fine because it was a variable rate HELOC so there is risk that the rate would go up over time as we are witnessing now. If you decide the terms for a home equity loan are more favorable compared to the HELOC then it's just a matter of knowing exactly how much you need for closing on a specific property because you don't want to get stuck paying on debt that you aren't planning on using right away. There was also a tax advantage in that I would deduct the HELOC expenses. I wish you luck figuring out which one works best.

Chris Seveney · Answer

I would recommend against it and here is why. When you take money from your HELOC, you are using 100% leverage on that new property. You are taking equity away from your home and getting back financing. It can be risky and if you yourself get into a situation where you have a loss of income, having a HELOC can be a saving grace whereas ifyou pull from it for a home and then cannot make the payment they will not allow you to draw on it.

For me, all about risk and risk tolerance, - which doing this for me adds a significant layer of risk.

Jonathan Greene · Answer

Pulling from Paul to pay Peter is never the best strategy unless it's part of a long-term, well thought out, high equity plan. People read too many blogs and think maxing out leverage is good, but most of the time it's not if you are newer because of what @Chris Seveney said.

Having equity in your home is a balloon you can keep in a closet for things, but too many people rush to use it. If you have to use it, using only a small part of it is best.

Should i use part of a home equity loan to put a down payment on another house?

Most Popular Reply

Contact Us