Newbie Question #2: can you execute a BRRRR with a HELOC or HEL?

Question

Hi everyone,

Today I was exploring how to pull some cash out of the equity on my current residential property and came across two popular options: a home equity line of credit (HELOC) and a home equity loan (HEL). These seem to have some advantages over a cash-out refinance such as lower closing costs and, in the case of HELs, being able to borrow up to 95 percent of your home's value in some cases. My question today is twofold: 1) can you execute a BRRRR strategy using a HELOC or HEL as opposed to a cash-out refinance? and 2) what are the advantages and disadvantages of doing so?

Andres

John Leavelle · Answer

@Frankie Woods

HELOC’s I would do.

Frankie Woods · Answer

@John Leavelle chaining properties together is no different than a blanket loan, which would also work in this case.  Being creative, while recognizing the risk, is the name of the game.  I'm about to take out multiple HELOCs on my properties.  But I understand the risk and appreciate the upside on a fantastic deal.  Happy Hunting.

Frankie Woods · Answer

@Andres Aguirre Your math is correct.  You can also get a HELOC up to 95% if you shop around. It's all personal preference and risk tolerance.  A traditional refi has the least risk, the HELOC has the most.

John Leavelle · Answer

@Andres Aguirre

Yes the HEL may allow up to 95% LTV, but, I would not bet on that.  You must remain conservative when analyzing any investment.  Hope for the best but plan for the worst.  80% is probably more realistic.  There are a couple things that concern me that would keep me from using them.  The first is it ties your primary residence (or investment property) to the success or failure of the new investment property.  It is the collateral on the loan.  Secondly, it would be a one shot deal.  Until you payoff the mortgage.

In your example you are totally forgetting we are discussing using these for the BRRRR strategy.  Most successful BRRRR deals are not acquired using conventional financing with 20% down/30 year term/5% APR.  Most are acquired using Cash, Hard/Private Money, HELOCs, etc.  The second misconception is you only get 70% LTV on a Cash-out Refinance loan.  You can get 70% to 80% LTV depending on the lender and type of property.  This is the same for HEL.  They differ between lenders.

I assume you would plan on applying for a new HEL on each new investment property.  To me this unnecessarily complicates to whole process.  You are tying multiple properties together in a chain like fashion.

I would need to see actual hard data that this is a viable plan.  I personally would not pursue it.

Andres Aguirre · Answer

@Frankie Woods @John Leavelle Thanks for your responses! I understand the risk with the HELOC and that it is a more short term option, but what about a home equity loan? Those can have a term of up to 25 years I believe so would be almost the same as a new mortgage and you can get an LTV of up to 95% which means you would be able to take out more money than with a cash-out refi.

One example would be the following: I purchase a $100,000 property with a 20% downpayment and a conventional 30-year mortgage at 5%. I use an additional $20,000 for rehab costs (private money or additional savings). So my total initial investment = $40,000. The ARV on the property is $145,000. When it comes time to refinance, a cash-out refinance would only be good for a 70% LTV which would be equal to $101,500. This is enough to payoff the initial mortgage and recoup your downpayment. You would still have $19,500 of your initial investment left in the deal. On the other hand, you could take out an HEL for an LTV of up to 95% equal to $57,750 ($137,500 - $80,000) which is enough to recoup your entire initial investment and then some. Even if 95% LTV is not achievable, the norm which is 80%, would still allow you to recoup most of your initial investment. I get that interest rates are typically higher on a HEL than on a cash-out refi and that could be one drawback, but if you workout the numbers and you don't intend to hold long term I could see the benefit of having more cash available to invest immediately in other deals outweighing the cost of the additional interest. Another drawback I can see with the HEL is having an additional lien on the property which limits drawing on the property in the future. Again, perhaps I am missing something here, but would appreciate your guidance.

Andres

Frankie Woods · Answer

The HELOC is variable.  So there is risk in using it.

John Leavelle · Answer

@Andres Aguirre

Most BRRRR deals are purchased and Rehabbed using Cash, Hard/ Private Money Lenders, HELOC, or Credit Cards.  In order to repeat the process you need to get your cash back and/or payoff the High Interest Loans.  Therefore, the Cash-back Refinance loan is the most used tool.

It sounds to me you are questioning using a HELOC versus the Refinance loan,  to continue the process, after the purchase and Rehab are complete.  My question to you is how did you purchase and Rehab the property to start with?  If you use a HELOC on your current residence that is only good for approximately 10 years.  The interest rate is variable and usually higher than a regular mortgage.  You should want a lower rate and longer term (30 years) to pay it off.  To me HELOC’s are a valuable asset to use for the acquisition and Rehab of properties. Not for long term financing.

Andres Aguirre · Answer

Hi @John Leavelle

I guess my confusion lies in trying to figure out why a cash-out refinance is the go-to option when executing the refinancing step of the BRRRR... Am I wrong in thinking that a HEL or HELOC, both of which have lower closing costs and offer higher LTVs, would be more beneficial for pulling out cash out of a deal than the cash-out refinance? I am likely missing something in my thinking... Is it perhaps that the cash-out refinance gives you more flexibility later down the road since you're not placing additional liens on the property?

John Leavelle · Answer

Howdy @Andres Aguirre

Most assuredly you can execute the BRRRR strategy with these tools.  I use a HELOC all the time.

I use it in conjunction with a Private Lender Loan and sometimes with a personal Line of Credit.  I like the HELOC because I only pay interest only payments until I do a Cash-out Refinance.  I can keep reusing it over and over again.  The HEL is a one time deal.  You have to re-apply for one each time.  The interest rate may be lower, but, it takes more time to deal with and you take a hit on your credit each time.  I’m not as concerned about the interest because I recover it with the Refinance loan.

Or are you opposed to the Cash-out Refinance all together and are speaking to using a HELOC from each property ?