Investor · Dallas, TX · Member since 2014 · 177 posts · 213 votes
Hi everyone. So my husband and I had been aggressively paying off our mortgage with the goal of saving up for a rental property after that, but with all of the information here and after talking with some investors at our first REI meeting last week, we thought it was time to stop talking about it and just.do.it.
So... we are working with a friend on doing a cash-out refi but the new payment is a little hard to swallow since it's $300 more/month and we've been so focused on getting out of debt... AND will eat into future cash flow when we rent out this property.
I need to know whether we should do this or not!
Current details:
Payment is $1,270
Interest rate 4%
Loan balance $108,000
Cash-out refi:
Loan Amount: $210,400
Conv., 30 Year, Fixed
Int. Rate: 5% (Cash-out Guidelines & No Points)
Monthly Payment (P&I, Tax, & Ins.): $1,580/mo
Cash Back: $95K
In our market, we were thinking $40,000 as a down payment on property #1, $30,000 on rehab, then use the $20,000 as a head start for property number two.
Should we do the cash-out refi?? We actually intended on eventually renting out our current house, so a higher payment would mean lower cash flow in the future from that perspective as well... Thoughts?
Providence, RI · Member since 2016 · 73 posts · 36 votes
8y
Perhaps I'm missing an important point. If you have sufficient equity, why don't you simply obtain a home equity line of credit? You can use the money when it's needed, without changing your existing note rate. Obviously, HELOC rates may rise, but why pay interest now if you don't need the money yet. Obviously, you know the exact details of your situation. I hope this helps.
Investor · Dallas, TX · Member since 2014 · 177 posts · 213 votes
8y
Wow I think you guys have convinced me that a HELOC is more in line with what we will be comfortable with... I really like that we would get to keep or current mortgage the same and only take out money when we need it. Also, with us having a lot of our income in bonuses and commissions it forces us to only rely on our salaries, and allows us to have big chunks for savings or paying off the HELOC...
@Jessica G. We have used HELOC, it's worked well for us, and we only use it to buy real estate. (You can use the money for anything, and this is when peeps can get in trouble)... We live below our means, and send extra to the principal to get it paid down quickly so we have more buying power. Just like a credit card.
Is there a difference between paying the mortgage down faster to increase buying power, and simply saving that extra payment in a checking account to increase buying power? Either way, it seems to me like the same thing?
No difference assuming you have the large down payment from the start to begin buying. For us, we chose to use the heloc and immediately began to buy, rather than waiting a few years to save for the down payment. Once we have the property, we pay the heloc down quickly with the cash flow, and at times some of our money.
Multifamily Syndicator · Houston, TX · Member since 2016 · 1k+ posts · 2k+ votes
8y
@Jessica G. Romanticized the idea of paying off our mortgage but then I know that the capital would just be redeployed at a later time in our lives anyway. As a result, I try to look at the deployability value of money over time, meaning if I can use this capital to invest now and get a decent return, I will.
Now, for your particular case, I think @Stephen Renehan made a really good point with the HELOC approach instead because finding a good deal can take time. In addition, you remove the pressure of trying to use that capital quickly if you go with the REFI approach.
At the end of the day, I'd say use the capital in your house now with the hope of receiving income at a later time.
Providence, RI · Member since 2016 · 73 posts · 36 votes
8y
Thanks@Ola Dantis! I agree that finding a good deal may take time. Why enrich a bank or mortgage company now, when you may not need the money for several months. Consider the HELOC as being preapproved for the funding when you need it. :)
Investor · Dallas, TX · Member since 2014 · 177 posts · 213 votes
8y
@Stephen Renehan@Ola Dantis Yeah that's the thing too, is we don't know WHEN we will find a house in this seller's market! And I definitely don't want to feel rushed and that I have to just buy something to have made all of this worth it.
And yes, if I could go back in time I would have used all of the cash we threw at the mortgage for down payments! Now we are paying interest on our own money, Ugh! Oh well, now we know!
Providence, RI · Member since 2016 · 73 posts · 36 votes
8y
@Jessica G.I’m glad you followed my thought process. I’d hate to have you do a refi, feel the pressure of buying a property and end up with the wrong one. I wish you the best in your search! 😊
Investor · Sacramento, CA · Member since 2017 · 7 posts · 2 votes
8y
@Chrissy Nelson Hi Chrissy, where out of state did you guys buy your rental properties? We're in Roseville, CA and are looking to buy an out of state rental too. Are you using a turn key property management company?
Investor · Dallas, TX · Member since 2014 · 177 posts · 213 votes
8y
Ok now I'm probably over thinking this, but what would be the advantage of getting a HELOC vs just saving up the cash for down payment + rehab? Is it only an advantage if you are able to refinance and pay off the HELOC? It just seems kind of backwards to use money from a HELOC, then use all of our extra cash flow to pay it off quickly? Didn't we just pay a bunch of interest for nothing? Why not just use our extra cash flow to buy in the first place? Sorry you guys but this is complicated and maybe I'm missing something??
Rental Property Investor · Honolulu, HAWAII (HI) · Member since 2011 · 4k+ posts · 2k+ votes
8y
Jessica Geisler you have three options.
The first is what I did which is sell because I am converting my sfhs to syndications which are LLCs and not like kind 1031 eligible.
The second is a cash or refi where you use when it’s still a good long term rental. If you are growing as an investor you should always be finding better stock.
And third Heloc. Here is some info I was writing on it.
Is it Possible to Use a HELOC to Cover the Down Payment on a Second Home?
A home equity line of credit, or HELOC, is one of the credit products available to homeowners specifically. Secured by the home itself, a HELOC offers a way to use the equity stored in the home at a lower interest rate than many other types of loans.
HELOCs can be used for everything from home improvement projects to large purchases, educational expenses, or even debt consolidation/refinancing. Speaking of large purchases, they can also be used to fund a down payment on a second mortgage—but is that a good idea? Any instance where you consider dipping into your home equity to pay an expense should be thought about with care. Although it’s your equity, a HELOC needs to be paid back all the same with interest.
Failing to handle this debt properly could hurt you financially and lead to negative consequences; however, handling it successfully can help you manage your expenses as well as lead to positive financial gain down the road. There are ups and downs to the whole thing. That’s what we’ll explore in this article.
What are the Upsides to Such a Move?
Home equity lines of credit come with variable interest rates, and you can make interest-only payments during the draw period. That’s typically the first 5 or 10 years, during which you can “draw” from the available funds on the line of credit, then pay it back either in full or by making the minimum payment, much like a credit card.
As of December 2017, the national average interest rate on a HELOC was around 5%, so a HELOC is a usually cheaper way to finance a down payment and closing costs on a new home compared to a cash-out refinance of a first mortgage. In a cash-out refinance, the closing costs and interest over time would be significantly higher—meaning you’d pay a great deal more in the end. Title searches, insurance, and other costs aren’t necessary on a HELOC, and that translates to less cost up front as well.
In addition, lenders look favorably on those who use their current home to put a down payment on a second home. Those borrowers are less likely to default on payments, and there’s also the pressure of residing in the secured asset. If they get into financial trouble, chances are good that the HELOC payment will still be one of the things that still get paid. Overall, there’s less risk to lenders, so they’re more likely to offer you better terms – a big upside to the whole process.
What are the Downsides to Such a Move?
While using your HELOC to make the down payment on a secondary home sounds like a great idea, there are some drawbacks you should be aware of. First of all, the fact that your primary home is securing that line of credit is a huge responsibility. If you do run into trouble and can’t make the payments at all, you could still lose your home—even if you’re making the payments on the first mortgage.
Before taking on that HELOC, you’ll want to make sure that you can afford all relevant obligations. This means both the interest-only payments during the draw period and the full interest/principal payments after the draw period is over. If you think you’ll struggle with the interest payments and don’t expect an increase of income, then you’ll want to think twice before signing on the dotted line.
Banks can also “call” a HELOC. If the lender sees that you’re not making the interest-only payments during the draw period, it can notify you that not only can you not draw any more funds from the line of credit, but your entire balance is due immediately. That can put you into a financial downward spiral and wreak havoc on your finances – all with your original equity on the line while attempting to build new equity.
HELOCs, as we mentioned earlier, are also variable-rate products. That means if the benchmark rate goes up, so does the rate on your line of credit. The super-low rate you’re signing up with could double over time—or go even higher. That higher rate means higher payments and will only increase the cost of your investment. While you can’t fully predict interest rate trends, you should pay attention to the Federal Reserve if you want to get an idea on those trends over the coming years.
With the new tax laws, using a HELOC for that purpose is no longer eligible for a tax break. Previously, interest from a HELOC could be a tax deduction. However, only HELOCs used for home improvement are eligible for the deduction. This fact will increase the expense of investing in a second home.
Lastly, buying a second home with equity from your primary residence means you’re also tying up much of your net worth in one type of asset. While real estate might be a solid bet right now, what if it isn’t in a few years? Portfolio management wisdom says that diversifying your investments is always a good idea; having that much tied up in two homes might be a dangerous prospect.
Conclusion
As you can see, a HELOC can be used to fund the down payment on a second home. There are benefits to doing so, but there are significant drawbacks as well. Take the time to think through what’s best for your personal situation before jumping in, and you’ll be much better off.
Rental Property Investor · Auburn, ME · Member since 2015 · 236 posts · 140 votes
8y
@Jessica G. - I was in a similar situation a couple years ago. I had my first property financed with a FHA loan and the rate was 3.2%. It also had their insurance of about $110 a month (gone now, $110 more profit). Most banks wanted me to refi, which of course was silly and one said they could do HELOC. Ended up with a line of $55k that has been used to buy 4 more properties.
Each time there was a way to pay the line off quickly. Once through just flipping, once with a deal with the owners of two buildings in which we got paid a nice sum back at closing and one just by paying it off with rental income (bought a sfh for $30k).
It is also nice to have the HELOC as an emergency cushion in case something big gives out in one of our properties. Peace of mind is a good thing.
Real Estate Agent · Jacksonville, FL · Member since 2015 · 1k+ posts · 1k+ votes
8y
The money is cheap. I would take it. It will be a very long time before it is this cheap. The HELOC will not be a lower payment since the term is going to be shorter. HELOC's typically have a variable rate. Going into higher rates, I would lock up as much cheap money as possible. The future tax deductibility of HELOC's is questionable.
What you do with it is the second question. I don't have all the facts about your other project, but on the surface it looks interesting.
Keep in mind debt is a tool. This is not a credit card or a fancy vacation. Done well, it should be a advance your goals not detract from them. I know there is a lot of discussion about being debt free, but is not possible to grow your investments with out taking on debt. If your goal is use leverage so you can live a better lifestyle then, I would reconsider. Otherwise take as much of it as you can get.
Turn key provider · San Jose, CA · Member since 2010 · 4k+ posts · 3k+ votes
8y
Using a HELOC can be a great way of accessing equity in your home and providing quick down payment money. Just keep in mind that it is not a fixed rate and we are in a rising market.
Investor · Dallas, TX · Member since 2014 · 177 posts · 213 votes
8y
Update! Closing on a HELOC soon and they gave us a great valuation, about $10k more than I was expecting. Hopeful that we will be able to get at least 2 properties out of this.
Now on to the next challenge of actually finding a deal and brushing up on landlording!
Update! Closing on a HELOC soon and they gave us a great valuation, about $10k more than I was expecting. Hopeful that we will be able to get at least 2 properties out of this.
Now on to the next challenge of actually finding a deal and brushing up on landlording!
Investor · Dallas, TX · Member since 2014 · 177 posts · 213 votes
8y
@Lana Lee We got $85k with a 1.6% margin for the life of the loan. 10 year draw period, 20 year repayment period, no minimum withdrawals or annual fees, no prepayment penalty for paying off the loan or closing it out early. basically we never have to touch it if we don't want to. We will see how it goes! Hoping to use hardmoney and HELOC to buy/rehab then refinance into a conventional mortgage and pay off HELOC/hml after a few months. Then repeat!!