Cash out Refi vs. HELOC for a buy and hold investor?

3 Replies

Sorry for the newbie question but I wanted to confirm with BP that it makes more sense for me to cash out refinance vs. getting a HELOC.

Current situation:

$190K balance on primary residence (Property A)

Fair market value = $400K

3.875% fixed 30 year loan (Year 4)


1) Buy another property for primary residence in the next year

2) Convert current Property A into a rental property

3) Would use cash out refi or HELOC (~$80K) to buy 2-3 more buy and hold OOS properties in the next 6-12 months

My rationale for using cash out refinance instead of HELOC

1) Current refi mortgage rate on Property A would be similar to current rate of 3.875%

2) The down payments toward the 2-3 OOS properties will be locked up for at least 5-10 years which makes it harder getting the cash to pay the HELOC down

3) Refinance rates would be fixed whereas HELOC rates are variable and may likely rise in the next 5-10 years(?)

4) The HELOC is for OO properties. Once I make Property A into a rental property, I would risk having the lender potentially cutting off my HELOC, right?

Is my assessment correct or am I missing something? Is there a scenario where HELOC makes more sense for a buy and hold / long term investor?

In my opinion, both options are bad choices. I am not a fan of using a HELOC or a cash out refinance on my primary residence to finance an investment property purchase. I would much rather use separate conventional financing to buy the investment property. The reason is fairly simple. If the investment goes south with a conventional acquisition loan, I only lose the investment property to foreclosure. If the investment goes soujth and I can't afford to pay the HELOC or refi because there is no rental income to support the debt service, I risk losing my primary residence to foreclosure.

I don't want to be homeless if the residential rental market suddenly tanks.

Your question can only be answered by you, given your risk tolerance and your ability to meet your debt service obligations in the worst case scenario.  

There is another option that is much safer.  You are planning to buy another primary residence in a year or so.  When you are ready to buy your next primary, sell your current primary residence if you can qualify for the Section 121 capital gains exclusion.  Take as much of your tax-free sale profit as you need to purchase the out of state investment rentals using conventional financing.  Use the balance of your sale profit as a down payment on your new primary residence.  Converting your current primary to a rental would most likely be a negative cash flow scenario, but you would have to do a cash flow analysis to be sure.

I partly agree with @Dave Toelkes . I personally think equity in a house is a waste of money. Every dollar you pay down on a mortgage you may as well have stuffed under a mattress. Equity does not earn an ROI. A house will appreciate whether it is leveraged or owned outright. Its a myth to think you are more secure. Your property taxes and insurance will still be there and those expenses will increase every year as the house appreciates in value. People pay off the one bill that stays level!

So I totally believe in taking as much cash out of a home as you can get. Where I agree with Dave is that I don't think you should risk your house to make risky investments. I stay away from "Equity" investments. I think there are plenty of safe, protected debt positions and private lending opportunities that will create a nice safe interest rate arbitrage on your HELOC.

Think of it this way: if you can get money at 3.5% and you know you can invest it safely and earn 7%, how much money would you want? All of it, right?

I like the HELOC better because most are interest only. I don't want to give the bank their money back as long as I can keep it working in some alternative investment.