Home Equity Loan vs. HELOC for downpayment on next rental prop?

48 Replies

Hi BP!  My husband and I live in the SF Bay Area where home prices have risen substantially in past years.  We want to leverage some of our home equity and use that equity as down payment for our 2nd rental prop.  We're thinking of drawing ballpark $50-70k.  

We contacted Wells Fargo Bank and a local credit union for ideas on interest rates. Seems like HELOC rates are much lower and so we're leaning toward that direction. Also both banks provide the opportunity to switch to fixed rates at a later time, granted we keep the HELOC open for at least 3 yrs.

Wondering if any BP members have done something similar? Pros/cons of HELOC vs. regular home equity loan for using as down payment on a rental prop. Thanks in advance!

they are the same thing.

heloc = home equity line of credit.

Unless I misunderstanding something

I too am looking at the same options now. I just applied for a HELOC, my plan is to use some for down payment of new rental property and also to take out enough to satisfy the 6 months reserves my lender wants to see for closing. Once I have closed I will put back the reserves and start looking for more properties.

Good luck and I'll keep an eye on this tread to see how you made out.

HELOCs typically have a lower interest rate because they are variable. Since all the talk recently is about the fed raising rates you need to make sure you understand that your payment will go up when rates go up.

I almost always recommend the HELOC over a Home Equity Loan for the sheer flexibility that it offers. The payments are usually lower because of the lower rate and because most are interest only for the draw period. I have seen some with a minimum based on the outstanding balance though so know what you are getting.

The key for me, though, is that you can reuse the HELOC over and over. If you choose to pay it off or down faster, you can access that money again at your whim. With a home equity loan if you pay it down faster you can not get that money back without going back to the bank. This makes the HELOC better suited for flipping strategies (i.e. fix and flips or BRRRR) but it can still be used for buy and holds where you want to pay the loan down faster with extra cash and then reuse for a downpayment on another property. Also, if you aren't using the money (i.e. you have it paid off right now) it costs you nothing to have the loan except perhaps a small annual fee, although none of my HELOCs have annual fees. With a home equity loan you will be making the monthly payments and incurring the interest regardless of whether or not you are using the money.

Ed 

Originally posted by @Edward B. :

HELOCs typically have a lower interest rate because they are variable. Since all the talk recently is about the fed raising rates you need to make sure you understand that your payment will go up when rates go up.

I almost always recommend the HELOC over a Home Equity Loan for the sheer flexibility that it offers. The payments are usually lower because of the lower rate and because most are interest only for the draw period. I have seen some with a minimum based on the outstanding balance though so know what you are getting.

The key for me, though, is that you can reuse the HELOC over and over. If you choose to pay it off or down faster, you can access that money again at your whim. With a home equity loan if you pay it down faster you can not get that money back without going back to the bank. This makes the HELOC better suited for flipping strategies (i.e. fix and flips or BRRRR) but it can still be used for buy and holds where you want to pay the loan down faster with extra cash and then reuse for a downpayment on another property. Also, if you aren't using the money (i.e. you have it paid off right now) it costs you nothing to have the loan except perhaps a small annual fee, although none of my HELOCs have annual fees. With a home equity loan you will be making the monthly payments and incurring the interest regardless of whether or not you are using the money.

Ed 

Thank you Ed you are a life saver. I asked something similar trying to find out what might be a better strategy. The up side I think, it can also be deducted on the taxes regardless of the HELOC is from a primary or investment property. I'm hoping.

Originally posted by @Ana Marie B. :

Hi BP!  My husband and I live in the SF Bay Area where home prices have risen substantially in past years.  We want to leverage some of our home equity and use that equity as down payment for our 2nd rental prop.  We're thinking of drawing ballpark $50-70k.  

We contacted Wells Fargo Bank and a local credit union for ideas on interest rates. Seems like HELOC rates are much lower and so we're leaning toward that direction. Also both banks provide the opportunity to switch to fixed rates at a later time, granted we keep the HELOC open for at least 3 yrs.

Wondering if any BP members have done something similar? Pros/cons of HELOC vs. regular home equity loan for using as down payment on a rental prop. Thanks in advance!

 Ana-

Have you dealt with WF before? I had a bad experience with them on financing a rental a few years ago. I bank with them now only because it's just a checking account and I don't have to deal with their lenders. I've shyed away from them because of that bad loan processing experience.

@Daria B. ,

Go Gators!

I spent several years of my youth in Gainesville, FL. To answer your question, yes the interest is deductable because the loan is against your primary residence, regardless of what you use the money for. If you have a loan against an investment property you can write it off against the income from the property. Always confirm with your CPA, though.

I have a love/hate relationship with WF. I have a HELOC with them which has been good. I have two business checking accounts with them that I am in the process of moving because they no longer offer no fee business checking. And they slow rolled us so badly on a VA loan in 2010 that I wound up just financing with someone else.

If I refused to do business with every bank that upset me though I would be done in this business. Sometimes you have to just forgive and forget. Unless it is Bof A, of course, I have a hate/hate relationship with them and will never do business with those @#$% @#$%^# again! Same deal, miserable experience with a loan that drug on for years, even after I had refinanced. All I can say is keep all of your paperwork and correspondence, because they won't.

Ed

@Edward B.

LOL

And I thought it was just me. But I completely understand about the love/hate relationship - I'm there with WF or the "pony people" as I refer to them.

Not cutting my ties completely but they are always dead last on my list when it comes to calling lenders. 

I'm coming out of my shell and considering the "creative" side of financing. 👀

Great, I'll pass the info on taxes to my CPA for his CPA stamp of approval.

I'm a bit of a pack rat when it comes to the investments-electronic and paper. I have trust issues :)

I like the idea of the HELOC sitting to be used and reused.

@Alexander Felice - Hi Alex, Yes Home Equity Loan and Home Equity Line of Credit (HELOC) are differ. Main difference is Home Equity Loans are fixed rate with typically higher rates than HELOCs which are variable rate. The former is like a 2nd mortgage where you get a lump sum and payments are set for around 15 yrs or more. The latter is more like a credit card where you only pay back what you use (with interest of course).

@Edward B. - Thanks! Appreciate your points and analysis. Will likely move forward with the HELOC.

@Daria B. - Hi Daria! Not sure if this makes sense at all, but we'd go through WFB for the HELOC, but not the rental property. We'd be purchasing the property out of state and will likely go through a mortgage broker. Guess that leads to our next question, how does using a HELOC impact financing? Last property we purchased, we used our actual savings so that was a different situation.

I think I get it @Ana Marie B. you are utilizing the HELOC from WF but actual financing of the rental will be from a different lender. You're using the HELOC I guess for rehab or other out-of-pocket expenses. This is something I want to investigate and do for a potential that needs work (buy and hold).

@Ana Marie B. , I think the difference between HELOC and home equity loan has been explained by others.

With HELOC you have the flexibility to draw from and pay back anytime you need. The interest rate is typically lower but keep in mind the rate will change, most often every quarter. So if you only need the money for a short period of time (such as fix and flip), you will have a good idea how much it cost you.

With home equity loan, the rate will be slightly higher than HELOC but it has a fixed rate. Some lenders allow you to pay back early without early payment penalty but some don't. After you pay it back, you have to talk to the bank again and go through the same process next time you want to borrow.

IMHO, HELOC is good for repeated use for short periods of time, while home equity loan is good for long term use of the borrowed money.

Now, for you case, since you are going to use the money as down payment for your next rental, I assume you probably is not planning to pay it back anytime soon. So home equity loan probably makes more sense. 

@Ana Marie B. ,

The lender that will be underwriting the investment property will factor the payment that will result from using the HELOC for the down payment into your Debt to Income ratio. If your DTI is still below their requirement then it should not be an issue.

@Yinan Q. - Thanks for your feedback!  I definitely understand the benefits to using a home equity loan (fixed rate being the main one), esp. since we will be using this as down payment.  In our case, however, we do plan on using this loan for the short term.  We don't want to carry this debt for very long.  

@Edward B. - Thanks for shedding some light into the financing piece!  Makes sense!  

Originally posted by @Ana Marie B. :

@Daria B. - Hi Daria! Not sure if this makes sense at all, but we'd go through WFB for the HELOC, but not the rental property. We'd be purchasing the property out of state and will likely go through a mortgage broker. Guess that leads to our next question, how does using a HELOC impact financing? Last property we purchased, we used our actual savings so that was a different situation.

Ana,

Go to a credit union. They're currently having a promotional rate for 2.99% for the first 12 months. It will be 3.5% after that. I believe WF's interest rate is higher than that, but I stopped doing business with them a while ago. I was rooting for you until you said you'd be using your HELOC money for out of state investment. Yikes, I hope it will not be an expensive lesson. As people said "out of state investing is where CA and NY investors go to lose money." Not sure if it has any merit, but I guess you'd find out in the near future.

Ed did a great job at explaining the benefits of a HELOC over the HEL. I gave him two votes for that.

Best of luck with your real estate endeavors.  

@Minh Le - Thanks for the word of caution! We will tread carefully :) WFB actually has a promotional HELOC rate through the end of the month for 2.24% which is lower than our credit union at the moment.

As for out of state investments being a bad idea I think it's all relative (even for CA and NY residents).  Think it all depends on location.

Originally posted by @Ana Marie B. :

@Minh Le - Thanks for the word of caution! We will tread carefully :) WFB actually has a promotional HELOC rate through the end of the month for 2.24% which is lower than our credit union at the moment.

As for out of state investments being a bad idea I think it's all relative (even for CA and NY residents).  Think it all depends on location.

A follow up question: what ceiling amount can you get for the HELOC, what is that based on?

@Daria B. ,

$500k max on a HELOC or up to 80% LTV of your primary residence based on my experience. I helped my brother got a HELOC bigger than that through another lender. They call it a "bridge HELOC". However, this lender only goes up to 60% LTV on this bridge HELOC product.

The beautiful thing about my credit union is that they can get you a HELOC in a week if everything goes smoothly, or two weeks max. Hav fun shopping for one.

I've got a HELOC at 90% LTV at 3% and a $75 annual fee. I got $46,600 and used it flip a house.

Originally posted by @Alexander Felice :

they are the same thing.

heloc = home equity line of credit.

Unless I misunderstanding something

 A home equity loan is a lump sum on which you would pay interest the entire time all or any of it is outstanding, whereas a home equity line of credit is something you can use as needed and on which you only pay interest on the amount used. 

Originally posted by @Edward B. :

@Daria B. ,

Go Gators!

I spent several years of my youth in Gainesville, FL. To answer your question, yes the interest is deductable because the loan is against your primary residence, regardless of what you use the money for. If you have a loan against an investment property you can write it off against the income from the property. Always confirm with your CPA, though.

I have a love/hate relationship with WF. I have a HELOC with them which has been good. I have two business checking accounts with them that I am in the process of moving because they no longer offer no fee business checking. And they slow rolled us so badly on a VA loan in 2010 that I wound up just financing with someone else.

If I refused to do business with every bank that upset me though I would be done in this business. Sometimes you have to just forgive and forget. Unless it is Bof A, of course, I have a hate/hate relationship with them and will never do business with those @#$% @#$%^# again! Same deal, miserable experience with a loan that drug on for years, even after I had refinanced. All I can say is keep all of your paperwork and correspondence, because they won't.

Ed

I couldn't agree more with you on BofA. Although I'd had a checking account with them for many years, they refused to give me free checking when I turned 55 so I defected to a Union Bank right across the street. I made sure all charges went through my BofA account before closing it, but despite their teller's assurance, after it closed, a service fee was applied, overdrawing the now-closed account. You can only imagine the can of worms that ensued. It took me a good month and much wasted time to finally get that d***ed account closed. Worse yet, just when the real estate bubble was about to burst, I was in escrow to sell a flip property and 2 days before it closed, BofA changed the terms of the loan and the buyers walked away. I had to hold that property for another 3 years and 3 horrible tenants, and then finally sold it for $150,000 less than the original deal. I will never deal with BofA again. BTW, Union Bank was the only bank where I had a HELOC that did not freeze my loan during all the bad years. I'd recommend UB to anyone!

Originally posted by @Maggie Tasseron :
Originally posted by @Alexander Felice:

they are the same thing.

heloc = home equity line of credit.

Unless I misunderstanding something

 A home equity loan is a lump sum on which you would pay interest the entire time all or any of it is outstanding, whereas a home equity line of credit is something you can use as needed and on which you only pay interest on the amount used. 

yeah I read the post like 3 times and it still slipped past me. I do heloc's every day but HEloans very rarely. #brainfart

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