Using your home equity to purchase rental units

Using your home equity to purchase rental units

Investor · Kingston, NY · Member since 2015 · 65 posts · 39 votes

Hi BP friends, 

I'm a landlord in upstate NY looking for some advice about generating revenues to purchase another buy and hold.  

For the past few months, I've been reading a great deal about wholesaling (I even started blogging about my journey here on the BP site). I took an excellent day-long course on wholesaling here in upstate NY that was incredibly informative. But, in the end, I'm circumspect, and when I shared my hesitation with someone here on BP -- and shared the fact that I have about 250k in equity in my own home -- he encouraged me to put this money toward buying another rental property.  And to forget about wholesaling altogether. 

That's hard to do.  I've spent so much time planning for wholesaling.  But, okay.  

Can someone here explain the process of using home equity to buy a rental property in a bit of detail for me?  Or recommend some further reading on the subject? Forgive me if I have overlooked a vital BP post on the subject. 

Here's what I understand thus far (forgive my novice naivete): I take out 100k on my home and purchase a buy and hold for the same price that cash flows out enough to pay off the equity line, pay all rental costs, and provide cash on the plus side to reinvest in the next property.  Where I get a little confused comes next: How would a potential refinance go on the new rental property? And would I then take out another equity line on the new buy and hold to purchase the next?  If I think about this too hard I imagine myself holding up a mirror to a mirror where my eyes are rolling into the back of my head like a pathogenic animal and I'm trapped inside infinite regress...

I love landlording and want to build a rental empire that includes retirement income alongside a way to revitalize my neighborhood. But we're levered up on our 1 main rental property and I admit I'm pretty scared to take out $$ on our house.  Not that I wouldn't, but I need to spend some time reading and learning about how this scenario plays out in the long term.  

Thank you in advance for taking the time to proffer up insights. All best.    

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Rental Property Investor · Manteno, IL · Member since 2009 · 2k+ posts · 2k+ votes
11y

I would also second the advice you were given on forgetting about wholesaling and using your equity instead.

Most people recommend going the wholesale route because they simply have no money to use to invest. But you have 250k to use (granted thats the equity and your heloc can only use up to 80 or 90% of the LTV of your homes).

Why spend all the time, energy and effort to find a deal only to turn around and sell it to another investor for 4 or 5k? If your goal is to make some extra money then sure, wholesaling makes sense.

If your goal is to start building a portfolio, then keep the deals to yourself and use your heloc to make it happen.

As far as an example of what you can do, here are two scenarios that might be used to grow a portfolio with a heloc.   One thing I'd preface this with though is that I started with a 42k heloc and now have 41 houses (#42 under contract) in about 8 years' time.   These aren't war zone houses either. 3/2's, 1500 sq ft, in nice areas with good schools that rent for between 1200 to 1600 depending on the home and area. 

I'll let you know which one I went with but here are two scenarios you could consider for using a heloc to grow a portfolio.

OPTION 1) USE HELOC TO BUY HOUSES AS CASH - THEN DO CASH OUT REFI'S TO PULL MONEY BACK OUT.

a) Take your 150k heloc and pay cash for the house (say 80k) and pay for the rehab as well (say 20k). So you're all in at 100k. The house should be worth 135k to 145k or so (70 to 75% ARV is what you'd want to target for a deal).

b) After you rehab and rent the house, then you can do a cash out refi up to 70 or sometimes 75% of the newly appraised value. Fannie mae has a special cash out refi program for people that pay all cash for the deal.  Technically, they'll only allow you to get your purchase money and rehab costs back out up to 70% of the appraisal value, so its not truly a cash out refi.  

But in your case, if you bought the deal right, you could get all your money back and then pay it back to your heloc and look for another deal.

Or maybe you end up having to come out of pocket 5 or 6k to make the numbers work. That would still leave you with 94k of your 100k heloc. 

c) At some point, you will hit a ceiling on the number of loans you can do this way. At that point, you'll need to find local banks and do commercial loans that will allow you to do cash out refi's.  Not as easy as you think as most local banks want to see skin in the game when doing cash out refi's.  So you might have to leave 10k or so into each deal.  At some point, you'd run out of money.

But you'd also be building revenue/cash flow with each deal you add. And you'll reach a point where the rental income will be able to feed your deals. But still, 10k (10%) is a bit pricey.


OPTION 2) Use hard money lender to finance the deals and use your heloc to feed the points/fees.

a) Find a hard money lender that will lend 100% of the purchase plus rehab costs. That leaves you having to pay points (typically 4) and a higher interest rate. But once you rehab and rent it, you would then do a rate/term refi for the 100k with a conventional lender (up to 10 properties) and after 10 properties, you'd be going to local banks to do commercial loans.

The benefit to rate/term refi's are that most banks are much more likely to do rate/term refi's on investment properties than cash out refi's. Seasoning is easier as well.

Again though, you'd be pulling out money out of your heloc after each deal to pay the points. At some point, though, you should have enough income to where your rental income starts to pay for the points directly.

A lot depends on how many houses you intend on buying a year.....

For me, I started out with Option 2. I pulled out the entire wad of money from the heloc (42k or 43k) and set it in my bank account.  I now had plenty of reserves to qualify for loans. 

I then bought houses via hard money loans and only had to come out of pocket for closing costs/points. Tax credit helped offset most of that though.  I was buying about 3 houses a year. And all my rental profits were going right back into the business to buy more houses.

Over the last 2 years, I've bought about 20 houses and seem to have settled into a pace of about 1 a month. Even with having to come out of pocket, my monthly rental profits have now far exceeded the amount i'm having to feed into my deals.

But there's nothing wrong with going slow and steady either. Pick a pace you're comfortable with and stick with it. You'll be surprised at how fast the time goes by and how much income your portfolio is able to start generating.

1 house a year making 200 to 300 a month would not be that big of a burden. In 10 years, thats 10 houses making 2k to 3k a month!

To me, I would definitely not want to spend the time, energy and effort for wholesaling to build enough capital to start building a portfolio. By the time you did, you may find that the cash flow numbers don't work anywhere near as well as they do today. 

Use your equity in your home and keep every deal you find. 

That would be my 2 cents (maybe 3 cents given how long this post was). :-)

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  • Investor · Winchester, VA · Member since 2015 · 21 posts · 14 votes
    11y

    Whether or not you can successfully refinance the property is completely dependent on finding a lender willing to do the deal.  You should definitely have someone lined up who knows your numbers and is on board with your plan, even if it does end up taking several months or longer for the property to season before they'll do the refi.

    On the surface the numbers look workable in that you meet the 1% rule with the purchase price (though not the ARV, assuming it would also be around $300k, which is admittedly less important from a brrrr perspective) and could conceivably get all your money out with a clean refi at a realistic LTV ratio.

    Is the property listed on the MLS? If so I'd be wary of why an apparently rental ready property advertised on the MLS hasn't sold in 30 seconds flat when priced at 50% ARV.

    Have you lined up a financing plan for the initial purchase?  Assuming you'd need about 20% down, that 25k personal loan won't get you in the door by itself, and you'll definitely need yet more cash on hand after closing to make sure everything gets rental ready and to handle the inevitable repairs/vacancies.  Round figures assuming 20% down on 150k, I'd say you should have your hands on at least 40k in liquid funds to pull the trigger.

    As inglorious as it sounds, until you have the necessary cash on hand, the best (and realistically only) thing to do is sit and wait while you build your bank roll.  If you jump in the second you have just enough for the down payment, you'll risk going belly up at the first bump in the road and you certainly can't count of the refinance until it's said and done. 

    To restate a post form a different thread, you can sometimes get as big a boost (or bigger) to you effective monthly cash flow by paying off debt you already have like car or student loans.  Taking out a new loan in order to make the down payment on yet another loan is a slippery slope if you don't read lightly.

  • Investor · Kingston, NY · Member since 2015 · 65 posts · 39 votes
    11y

    Thanks, Ryan.  

    I check the public auction records every day in my area, and today is a good example of something interesting showing up.  

    I live in one of the nicest neighborhoods in a mid-size city in upstate New York. The city has every class of neighborhood, from slummy areas to tree-lined streets where professionals live, like us. The person who sold us our house bought it before the crash at 460k, and we bought it in 2011 for $300k, a five bedroom huge Queen Ann Victorian with a legal rental on the back.  I'm obsessed with finding a deal in my neighborhood because I figure it's best to start in an area I know well and am comfortable with.  

    So today I noticed that a foreclosure two blocks away will be starting at auction at 60k. It's in my neighborhood -- a 4 bedroom 1.5 bath. Would probably rent for around $1800/mo at $190 ARV. I haven't checked closely, I'm just ballparking based on what I know about the area.

    I can't move on this because according to what I've learned I must first try and qualify for a loan so that I can refinance down the road (right?) and of course I also have to figure out where I can get a good line of credit on the house we live in. Plus, there's no way for me to know what the inside of the house is like, right? Since it's a foreclosure. Sure looks nice on the outside, though. With a HELOC we could potentially rent out our own home, use the money on the rental to pay back the HELOC and move my family into the foreclosure house while we work on it. Then do the cash/refi, move back home, pay back the HELOC and ideally have some cash to start all over again.

    Only one problem, aside from the fact that I haven't lined up my loans.  Well, two problems.  Again, I have no idea how much damage is on the inside of the house, and secondly...

    I'm too scared.  My real estate agent says that foreclosures are a big pain in the *** and he doesn't want me to do them.  

    Again, thanks in advance to all commenters.  

    Best, 

    Amy

  • Investor · Midlothian, VA · Member since 2015 · 980 posts · 823 votes
    11y

    Amy,

    I have run into HELOCs that require a minimum payment of say 2% of the outstanding balance vice just an interest only payment, but make sure you are getting a quote for a Home Equity Line Of Credit (HELOC) and not a Home Equity Loan. The first is revolving debt like a credit card (payoff and use, payoff and use) the second is an installment loan like your first mortgage or a car loan.

    Definitely shop around. I have not recently, but you should be able to get a 10yr draw with interest only payments I would think. Many places used to open a HELOC for free too. Those days may be gone but I would think it would be less than $500 and less than $1000 for sure. Again, once you open it, it doesn't cost you anything unless you pull money off of it.

    In terms of the monthly payment, make sure you factor that into your holding costs. You can simply ACH (electronic transfer) money from your HELOC to a checking account so you could make the payments with the HELOC if you had too. Maybe not directly, but certainly indirectly, i.e. transfer a chunk of money to make a couple months payments ahead of time. The monthly payment should not concern you because if you have done your due diligence it will all be factored in to your equation.

    To specifically answer your question: yes, it makes sense to see how much you qualify for to see what price point you will be at. Personally, I would take as much as they would give me. For my last one I agreed to 5.75% vice the high threes so that I could get 90% LTV vice 80%. That equated to another ~$30k in capital. As long as you use the money intelligently for investments vice vacations or a new car it should pay off. It is better to have access to the capital in my opinion rather than a better interest rate. The interest rate is just part of the cost you calculate on your investments or deals so you control its use. If you need the extra capital, though, and can't access it yourself you need to go to someone else for it and it is out of your control.

    In terms of flipping, make sure you know what you are doing and are very conservative on your first deal. It will make it extremely hard to compete with the investors who know how to run thinner margins and don’t require as much of a buffer but I highly doubt if they are putting up their homes as collateral if the deal goes bust. If you start out wholesaling like you mentioned that should give you a leg up. On the other hand, getting that first deal done is very liberating. It’s like renting your first home (Wow, people really will pay me to live in my property!) That aha moment really helps get the ball rolling.

    Ed

  • Investor · Kingston, NY · Member since 2015 · 65 posts · 39 votes
    11y

    Hi Ed, 

    For my last one I agreed to 5.75% vice the high threes so that I could get 90% LTV vice 80%. That equated to another ~$30k in capital. As long as you use the money intelligently for investments vice vacations or a new car it should pay off.

    I'm not sure what you mean here by vice.  Can you unpack this a little more so that I can understand?  Just explain it to me as if I were a three-year-old.  

    Thanks so much, 

    Amy

  • Investor · Midlothian, VA · Member since 2015 · 980 posts · 823 votes
    11y

    Amy,

    You don't have to qualify for a refinance loan before you flip a property, but it will give you more of a warm fuzzy if you have someone who says you should qualify for a loan before you get started. You can always run the risk that you won't be able to refinance it. Based on what little I know of your situation, I don't know why you wouldn't qualify for one though. The more properties you acquire the harder it will be but if you are just starting out and have good credit and the debt to income you should be fine. Understand that on an investment property they will probably only do 70% to 75% LTV. Just factor that in. Again the HELOC would let you move fast, that's why I recommend having it regardless if you are looking at a deal right now or not.

    I am very impressed if you have a family that would allow you to move into a rehab. Or even just move twice in one year to support you REI habit. Be careful that you are not overestimating their enthusiasm because it can be a big, and I mean HUGE, strain to do what you are proposing. Of course, it can be very lucrative too.

    Ed

  • Investor · Midlothian, VA · Member since 2015 · 980 posts · 823 votes
    11y

    Amy,

    I have a three year old so this should be easy.

    I had a 1st mortgage at 70% LTV on a $300k property, so ~$210k mortgage.

    A HELOC with an 80% LTV would only give me $30k to play with on the HELOC.

    80% of $300k is $240k minus the first mortgage ($210k) equals thirty thousand.

    Because it was only 80% LTV they were offering me an interest rate in the high threes or low fours, I can't remember (i.e. 3.75% or 4.25%).

    OR they would give me a HELOC at 90% LTV with a rate of 5.75%.

    90% of $300k is $270 minus the first mortgage ($210k) equals $60k to play with so $30k more than the 80% LTV loan. $60k - $30k = $30k.

    So as long as I make more than 5.75% on that money, an investment or deal is worth it. 5.75% is kind of high to overcome without taking on some risk but those opportunities do exist so if you are smart in how you use it it makes sense. Could be a flip, could be a buddy who wants to dump his $15k Harley for $10k because his wife is making him get rid of it. Most people can’t come up with $15k on the spot let alone $50k or $60k for a property. So if you have the knowledge, i.e. know what the Harley is worth, and access to the cash, you can take advantage of the opportunity. The Harley example is fictional by the way, but you get the point.

    Ed

  • Investor · Los Angeles, CA · Member since 2015 · 40 posts · 10 votes
    11y

    Hey Amy, thanks for starting this incredibly educational thread. Please report back and update us on how you decided to proceed. I'd also love to know how everything evolves.

    Best of luck! Kaylyn

  • Baltimore, MD · Member since 2015 · 54 posts · 3 votes
    10y

    I have equity in my primary residence but wanted to use equity from my rental but discovered I owe more than the property is worth....  :(     Are there options for me besides using my primary residence?

  • Investor · Birmingham, AL · Member since 2015 · 10 posts · 4 votes
    10y

    @Amy Zemser there's been some great advice through what I've read.  I would encourage you to source your deals through direct marketing.  You are interested in wholesaling, and it sounds like you would say that's one of your real estate strengths (or most knowledgable area).  Always try to play to your strengths!  As others said, you don't have to (and probably shouldn't) pass along your good deals to others simply because you've sourced them like a wholesaler.  But it's a great way to chase down good deals if you have the knowledge and drive.

  • Awais SheikhPro Member
    San Antonio, TX · Member since 2018 · 28 posts · 7 votes
    8y

    @Amy Zemser 

    Hi Amy

    Wondering how is it going for you? What did you end up doing?

    Did you start your real estate journey?

    Would love to hear, Im in the beginning stage..

    Thanks

  • Investor · Kingston, NY · Member since 2015 · 65 posts · 39 votes
    8y

    I haven't gotten very far. Am now taking an online course to get my real estate license (I want access to the MLS) and also took some part-time work to generate some revenue to invest in real estate. I'll keep you posted, thanks for writing!

  • Investor · Portland, OR · Member since 2019 · 23 posts · 23 votes
    4y

    @Mike H. 6 years later, and just want to say thanks for that response! My planned approach was more or less what you outlined, and really appreciate seeing all that detail. Now just to get the HELOC paperwork finalized.....

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