HELCO scenario

12 Replies

Hello guys/gals,

I have been browsing through bigger pockets for some time now and finally ready to post some questions and comments. First off let me explain who I am and where I come from. I am currently active duty military actually forward deployed in support of OEF. I am from Southern California and own a couple of rental properties near the base in Southern California as well as one in Phoenix, AZ. I am 27 years old and expecting my first child at the beginning of November. I want to provide a life of financial independence for my family and not have to worry about money. I have owned the aforementioned properties for about 5 years now and have built some equity in them. Ok enough about me and here are my questions(s).

Property 1 in phoenix, AZ original purchase price 120,000 in 2009 at 5.5%, I refinanced last year and current balance with the refinance cost into it is 115,000 and interest down to 3.25%. Monthly mortgage with insurance and property taxes included is $750 a month with $46 HOA fees on top. House was appraised at $188,000 this year. This is also a VA loan. Rental situation is I pay a property management company to manage the property and they just signed a new tenant to a 2 year lease (that's great J) at $950 rent. Property management takes up 75$ a month for management fees. So in the end the numbers aren't the greatest at $950 (rent income)-$750 (mortgage, insurance, property tax)-$46 (HOA Fees)-$65 (landscaping fee)-$75(property management fees) = +$14 a month.

Property 2 in Southern California was purchased for 75,000 in 2009 at 4.25%. I utilized the conventional loan and put down 15,000 and current balance is 55,000. Monthly mortgage with insurance and property taxes included is $450 a month. Property 2 was appraised at $85,000 this year. I have tenants in the property and current rental income is $770 a month and property management takes $70 a month. Numbers are $770 (rental income)-$450 (mortgage, insurance, property tax)-$70 (property management fees) = +250 a month.

There was the breakdown of the properties so there isn’t any confusion, sorry if I put too much or confused anyone.

My question is regarding HELOC. Here is my thought and some numbers, please advise and tell me if I am missing something or this plan looks solid.

I was thinking about taking out a HELOC on property 1 and paying off property 2 completely. This would leave property 2 with no balance minus this HELOC monthly costs. However, here are the numbers as I see it. Property 2 has 26 years left until the current loan matures, which will incur a total cost of $145,000 dollars total and $70,000 in interest. Current rental rate is between $750-$800/month minus the property management fees and that's $770-$70=$700/month profit 100% after I use the HELOC to pay off property 2. That's $700/month x 12 months is $8400/year. If I go further and break that down to the current length of the loan that's $8400/year x 26 years left, which is $218,400 (all profit opposed to interest to the bank and or original loan).

I understand I still have to pay the HELOC of $50,000 from property 1 back; I would re-invest the 100% profit of $700/month from property 2 which is $8400/year. $50,000 divided by $8400 is 5.9 years. So that is 5.9 years to pay off the $50,000 opposed to 26 years and a lot more profit in the end for me opposed to anyone else. I understand there are other fees, costs, vacancies for the rentals, broken items, etc.What are your guys's opinion's regarding this scenario.

Thanks

Lee

First, thanks for your service.

Since you're not bumping up against any mortgage limits and aren't trying to close out a mortgage to buy another one, I think the analysis comes down primarily to the interest rate on P2 (30 years at 4.25%) vs the HELOC you could get on P1.

You'll still have a payment on P2 for insurance and taxes, so it's just the principal and interest payments that would be different in the two scenarios. I don't think you're going to get a HELOC rate that's a lot better than 4.25%, so I don't think that's a clear winner. Once you consider that most HELOCs (as opposed to second mortgages) are variable rate, I think the idea loses. The payment for insurance and taxes won't be monthly anymore, which could help or hurt your situation. When it's escrowed monthly, you can't forget about it and it's very easy, which might be a factor if you're deployed or otherwise occupied.

To analyze further, consider the Interest payments on the two loans against each other. That's the money you're losing every month. Then, consider the total principal and interest payments between the two. That's the cash flow you're losing every month. Then consider what happens if the HELOC rate goes up 2% (if it's a variable rate.)

Thank you for your reply. I see what you're saying, however, one is over 26 years and one is over 5.9 years, a ton of interest to be saved. I understand the interest could jump yearly at .25% at a time roughly though. Additionally, I could put down a lot more than the 700 profit from the rental income towards the HELOC note. Am I looking at it wrong 26 years of paying 350+ a month interest (current mortgage) vs paying interest and principle on the HELOC in less than 5.9 years. If I pay an extra 300 on the HELOC note for a total of 1K a month, so 12K a year it would be paid off in 4 years opposed to 26 in the end. Maybe I am looking at it wrong???

Lee

And in the end the HELOC monthly payment just estimating lets say $200/month, the rental income of $700 a month is 100% none of my money and just income paid from someone else. Now the entire $50,000 could be paid off with their money in 1/5 the amount of time as I am currently paying. If i keep the current loan what it is at at least 15 more years will yield $300+ in interest to the bank, which is $300 x 12/months x 15/years is $54,000. what are your thoughts??

Lee

What's the rate and amortization period on the HELOC you'd contemplate on P1 to payoff P2? With the actual figures, I'll be better able to give you the math on either side.

I think you're mixing together a couple of unrelated concepts and if we can break the situation down to the basic math, it's easier to compare the two scenarios apples-to-apples.

to be honest, I haven't and I have just been looking into and crunching numbers. I think i am missing something though. Because I see that a HELOC note will not have a prepayment penalty, so i can put down almost $800 more on principle each month for 4 years opposed to 26 years. I'm sorry if i am repeating myself regarding, this but there is definitely something i am missing. I am new to this and trying to learn everything I can about the HELOC or even second mortgage to payoff property 2. Can we go off a rough estimate of the current prime plus or minus a couple minutes for rise of the interest rates over the next couple of years? and compare. i think i see it as being free and clear with both notes within 4 years vs 26 years. And I think I see what your saying that it will just come down to how much I really save in interest in the end. The part I am not getting is that i would continue to pay this interest for 26 years vice 4. Please help me understand lol.

Lee

You're right. It's going to just come down to the interest payments in total, which is driven by rate, outstanding balance, and duration.

Unless you have an extremely unusual mortgage on P2, you could just pay extra towards the P2 mortgage every month. That extra payment would go directly against the mortgage principal, just like paying extra on the HELOC would. Every extra $1000 paid to the mortgage is $1000 that you aren't paying monthly interest on, even if your mortgage payment doesn't change. (Most mortgages do not re-amortize, so your payment stays the same, but the interest calculations are monthly, based on the actual balance outstanding that month, so it reduces the term of the mortgage, even if the normal payment doesn't change.)

I'm not on my desktop PC at the moment, but I'll get on it later and work up a quick spreadsheet and copy the numbers into a BP post with some explanation.

OK, that would be great. I just calculated some of the stuff we have been talking about. My current mortgage is $450. $350 to interest and $100 going to principle. If i take the same scenario and apply the remaining money to the principle of property 2 it will be $650 to principle a month and the remaining $350 to interest. that's if I utilize the plan and come in with $300 of my own money on top of the rental income of $700 a month to equal $1000.

So, crunching these numbers would equate to Scenario 1 is $650 extra month to principle x 12/months is $7800/year. the current balance on property 2 is $55,000. So $55,000 divided by $7800 a year on the extra principle would take 7 years to pay off. 

Scenario 2 would be to utilize the tenant income for everything and not come in with the extra $300/month from myself so it would look like $700/month rental income minus mortgage which is $450/month, which equals $250 extra per month towards principle. So $250/month principle x 12/months is $3000/yearly extra on principle. $50,000 divided by an extra $3000/yearly principle payment would take 16 years.

Scenario 3 is to utilize the HELOC and pay off property 2 and yada yada like above. $700/month rental income all goes towards the HELOC note which is would equate to $700/month x 12 is $8400/year. $50000 divided by $8400 is 5.9 years to pay it off.

Scenario 4 is the same as above, however I add my exttra $300/month on toop of rental income of $700/month to equal $1000/month being applied to the HELOC note. $1000/month x 12/months is $12000/year. $50000 divided by $12000 is 4.1 years to pay off the HELOC note.

I hope I am seeing it in clear vision lol. I would love to see the spreadsheet that you are talking about and the amortization regarding the HELOC and property 2 numbers.

Lee

And I understand that the HELOC payment would be 1/2 the cost of my current mortgage of just principle and interest. SO, just saying that would save money if the prime rate was comparable correct? Thanks again

**This is on a side note. I remember you saying above that as long as i wasn't taking out a HELOC to purchase another property I would be fine. I am actually looking to purchase another property utilizing my left over VA money for a second VA loan because of me moving soon. That wouldn't have any affect on it correct? Completely separate.

Lee

Lee an amortization calculator shows that 75,000 at a 4.25% interest rate should make your payment 368.95 a month. That difference is 81.05 a month or 972.6 a year which is probably your property taxes or insurance that you have rolled into your payment. You need to strip out the escrow when running your calculation because those will always be with you and will skew your numbers. I am not sure of the terms of your HELOC but if they amortized it over 30 years that would be no different then refinancing your current debt of 50,000 conventionally and dragging that out over 30 years. You may want to look into refinancing that property at a 15 year rate and then taking the additional money and putting it towards the principal every month.

I see what your saying and understand the many different aspects of it. What is the best way a HELOC note would be utilized for, larger debts? And Jim stated earlier that as long as i want taking out a HELOC from property 1 and purchase another property with it, is that hard to get approved or sought after?

A few things that you might consider.

1)  Put extra cash-flow on P1 to reduce the balance and then do a recast.  It will keep the rate and the duration but recalculate the payment.  You need better cash-flow out of this property.

2)  Sell P1 and use the cash to buy another properly like P2, if prices haven't gone up to much you would have a small loan and a lot of free cash flow.

3) Use your HELOC for a down payment on P3. if you have enough cash-flow then turn your monthly cash-flow towards paying down one of the loans or saving for P4.

Bob E. MBA, LD Funding, LLC | [email protected] | 909‑353‑3863 | http://www.LDFundingLLC.com

I really do need better cash flow out of property 1, I have thought about putting a little extra on property 1 and property 2, but thought I could focus on property 2 as oppose to property 1 with either a HELOC or something then turn that $700-$800 cash flow into property 1. might just divide the 2 equally and apply them additionally to principle. However, i am still in the game for Property 3 and property 4,

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