I am brand new to real estate investing and I am looking for ways to get involved ASAP. I have heard a lot of good things about home equity loans or home equity lines of credit, but I cannot seem to see the bigger picture.
For example, if I take out a home equity loan to purchase a new rental, I now have created three debts. 1) The mortgage on my current home which I took out the home equity loan on, 2) the mortgage on the rental, and 3) the home equity loan. I keep seeing people raving about how this is the way to go, but all I can see is that I'm going further into debt. Why would I go this route rather than saving up a down payment and then only having the first two above-referenced debts.
I have been trying to figure this out on my own, but I find that I'm just stuck. Can somebody please tell me how it can be a good financial decision to take out a home equity loan to purchase a rental?
While it's true you've created a third debt, you have also created a second income without using any liquid cash. Imagine you have $40,000 in available equity in your home and you see a great four-plex hit the market for $200,000. You only have $15,000 cash, so you're not able to put the 20% required down payment. But you can get a HELOC for $40K, use that as a down payment on the $160K first mortgage on the new four-plex. It's essentially 100% financing. Just be sure to calculate the HELOC payments in your analysis on the four-plex.
For those that are comfortable with the additional debt level, it's a great tool. Others are leery of that, to each their own. I have a $50,000 SFH that I own free and clear, I use a HELOC (80%) on that to fund my down payments on new investments. Everything else is 70-80% LTV, 30 year fixed mortgages. Throw all the excess cash at the HELOC, rinse and repeat. Or you could be more active and BRRRR, but I didn't get into this to work that hard. :)
@Cooper Walker Debt (and risk) is not for everyone.
It's up to you to decide whether it's a good decision to take a HELOC based on your risk tolerance and financial goals. I can tell you that from my personal experience, taking out a HELOC on my primary residence was one of the best 2 or 3 decisions I've ever made in RE. It parlayed my ability to get a large unsecured credit line which allowed me to double the size of my portfolio.
If debt is not something you're comfortable doing, then I would recommend finding a partner and adding value in some other form. Sweat equity, finding the deals, project management, etc.
Thanks, Will. I really appreciate your input. You, like many people I've heard from, are strong believers in HELOCs. I guess what I'm looking for are some hard numbers. I want to see how it works. Without seeing numbers, I can't seem to wrap my head around how adding more debt (without adding more cash flow) is a good idea.
Once you dipped into your HELOC were you able to put yourself in a position where the cash you were earning covered the new debt you incurred?
The good news is you have already saved up the money for the DP. The bad news is it is dead and buried in your home. Sad but true, it is dead.
You bring it to life, force it to earn it's keep and benefit immediately by making it earn it's keep. It is your own personal revolving bank account. Low interest and available as you need it. In essence you are buying a property with 100% leverage which is going to produce the highest possible positive cash flow when a property is purchased properly.
You take your rent checks and deposit them directly into your HELOC account and use it as your business account.
You earned and saved that money, it is now your business financing and you work it like a mule to make it now work for you. If you leave it in your home it is useless.
I have a 200K HELOC I have used and repeatedly reuse for 10 years. Best money I ever saved and now it works for me. You do not work to make money you make money work for you.
Alex, I think you are beginning to make me understand how this can be beneficial. So, if I understand correctly, you factor your HELOC into your analysis on how much you will owe and make each month. Then, do everything you can to pay back the HELOC. Once that is done, you've put yourself in a good position to begin earning some cash.
Do I understand this correctly?
You’re on the right track. The following example includes broad assumptions and really rough numbers, but it will help you grasp the theory.
Assume the four-plex in my example above generates rents of $800/unit, $3,200/monthly income. After expenses (assume 50% for our example) you have $1,600 in cash flow to service the debt, both first mortgage and HELOC and return a profit. The first mortgage of $160,000, 4.5% for 30 years is $810. The HELOC payment, $40,000, 5% for 10 years is $425. (HELOC's are typically higher interest, shorter term. At least mine is. Combined debt service on the HLEOC and first mortgage is $1,235. After you pay this you are left with a profit of $365/month in addition to the principal reduction each month. You invested $0 in cash, so your cash on cash return seemsinfinite, though you will have some loan costs that would make it technically not so. A better metric may be a return on your equity.
Personally, I keep a certain level of reserves in my checking account each month. At the end of the month, anything over that gets applied to the HELOC. I had to replace a furnace last week, so this month I will apply $1,500 less to the HELOC. I could replace the furnace from this month's cashflow, so while I don't pay off the HELOC as much as I'd like this month, I live to see another.
Hope this makes sense. Let me know if you have any other questions.
Keep in mind, when you pay the HELOC off, your cash flow from the four-plex "increases" $425/month, to $790/month.
This helps a lot. Thank you, Alex. Because I'm new at this it was hard for me to believe that you can take out a HELOC and new mortgage on a rental and still be cash flow positive. Looks like you can do it with the right property though!