Planning on purchasing my first rental property with a HELOC...
Rental Property Investor · Santa Cruz, CA · Member since 2015 · 3 posts · 0 votes
I would be very new to this industry and business on real estate investing. I came to the conclusion after watching multiple online tutorials, that I would grab the equity out of my primary residence to purchase a rental property. I have a few of questions:
1. When purchasing a rental property with a HELOC, should it have to be bought outright? Like if my HELOC were $100K, I would have to only purchase a home under that amount?
2. When the HELOC is being paid off, is that line credit purposeful for anything else other than home upgrades?
3. Who are the best lenders for HELOCS
Dear Margaret,
I just went through the motions of seeking a HELOC for a down payment, along with a traditional mortgage to cover the difference, on a duplex. Though I eventually did not use a HELOC, I will share what I learned. Before diving in, consider that every lender has their own rules and that some of these statements are true for some lenders, not true for others. Also, they all play with different thresholds like 80% Loan to Value (L/V), or 85%...you get the picture. My advice is, go talk to smaller, local banks and credit unions. They tend to be more flexible. Now on to the good stuff:
First, you can absolutely do this. When I presented the idea to my lender, the first question they asked was, "What is your Debt to Income ratio?" My lender had hard limits. 40% or below AFTER the HELOC is considered. Since my ratio before the HELOC was about 34%, that meant I had about 6% more debt I could incur. To find our your D/I ratio, add up all your monthly payments towards debt (installment loans, mortgage, car loans, etc.) and divide that number by your gross monthly income.
Second, they informed me that, should I also apply for a mortgage on this property, my D/I ratio must remain below 43% AFTER THE MORTGAGE. Now, here is where things change. Let's say your gross monthly income was $5,000 after the HELOC. When calculating your D/I ratio for after the mortgage, you get to include 75% of your expected rent in your monthly gross income. So if you expect to get $1,000 in rent, your monthly gross income for this D/I ratio will be $5,750.
All this means, no, you do not need to buy a house in full using the HELOC. You will just need to run some numbers to see what you can afford. Call a local lender to ask for advice, or to see what their policies are.
Regarding the repayment: a HELOC is a line of credit, like a big credit card that's secured by your house. You open it for a certain draw period (usually 5 or 10 years). During that time, you can draw up to an overall maximum amount (your limit). Then, there is a repayment period (typically 15 or 20 years).
Some are structured such that, during the draw period, you only pay the interest that has accrued. Others, you pay interest and principle. Some have stipulations like, "you must keep the credit line open for 3 years minimum or pay fees". Either way, if you pay back some of the principle, you can draw it back out again within the draw period. Example: you open a HELOC for $100,000, 10 year draw, 20 year repayment, at 5.50% interest rate. In year 1, you draw $85,000 for a down payment and to cover closing costs. You immediately start making monthly payments, as calculated by your lender (or snazzy online calculators if you are looking to get some rough ideas now). By year two, you have paid back $2,000. Then, your roof starts to leak badly! So, you draw out $6,000 to replace the roof, meaning you have drawn $89,000 from your $100,000 line. You could still draw $11,000 more. Maybe you receive a bonus from work and pay back $30,000 in a lump sum. Now, you could draw out $41,000 more for another down payment. But by the end of year 10, they turn off your ability to draw more money and you must focus only on repayment.
I hope this helps paint the picture, and I wish you luck!
Cheers!
@Philip Davidowsky Thank you for sharing such useful information! Hope I can get the ball rolling!