HELOC vs. Cash Out Refi on First House Hack

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HELOC vs. Cash Out Refi on First House Hack

Lauren C.Pro Member
Rental Property Investor · Hamilton Township, NJ · Member since 2012 · 211 posts · 149 votes

Hi All!

I know this topic has come up before but I read most of the past forums and those asking the question are either asking about a property they paid cash for or used hard money to acquire it. I'm in a slightly different boat.

I recently purchased my first duplex. It will be owner occupied for 1 year until I buy and relocate into another small multi. We've put a lot of money and work into rehabbing the units and I would like to free up some cash for the next deal as well as pay off a credit card we used to assist with rehab. (New card with 0% APR for another 10 months)

Here are the numbers:

Purchase Price- $117,000

Down Payment- 20%

Current Mortgage Rate- 4.875

Rehab Costs- $50,000

- We did A LOT of the work ourselves and while we haven't had it appraised yet, our realtor is confident it will appraise for at least $190,000.

I called a bunch of banks and the best rate I can find for a cash out refi is 4.2.  Lower than my current rate! In order to make the deal "work" in terms of cash flow, I would only plan on cashing out about 30k. 

So here's my dilemma that I'm sure others have.

Do I do the cash out refi, pay a few thousand in closing costs, get a lower rate, but increase the mortgage payment thus decreasing cash flow a bit. (I'd be right at $100 a door after the refi. This accounts for all expenses, repairs, vacancy, capex. I'm very conservative in my numbers for reserves.) Also, are the closing costs worth only pulling out 30k?

or

Do a HELOC which people seem to love as they can borrow and pay it back at often as they like?

Pros- No closing costs. Lower interest rate on the cash only when I use it. 

Cons- According to the banks, the HELOC rate is only locked in for 5 years and then can increase up to over 5-6% and I heard stories of HELOCs being called back with not much notice.

Overall, my goal is to pull 30-35k to pay off a credit card and use as a down payment for the next small multi.

What do you guys think?

Side question- Can I do a cash out refi AND a HELOC afterwards on the same property? Can I do both?

Thanks in advance for reading this whole thing and any advice!

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Mike H.
Rental Property Investor · Manteno, IL · Member since 2009 · 2k+ posts · 2k+ votes
9y

Therein lies the value of the house hack. Keep buying properties as your primary residence so you can get the cheaper financing as you grow your portfolio. And yes, I believe you can get heloc's for each house.

That being said, there can be a limit for some banks on how many mortgaged properties you can have in order to qualify for their heloc. So even though fannie mae allows up to 10 financed properties, that is for first mortgages only. Some banks might not do heloc's once you have 4 or more mortgaged properties - even if it is your primary residence.

But again, some will. Just keep shopping around.

It is the cheapest money you're going to get. And if it gets to where you make a decision that you aren't going to need it, then pay them off and close them out.

In terms of credit and dti qualifications, that is definitely a consideration when it comes to heloc's. But as a landlord you should be able to use your rental income (or a portion thereof) against the payments to offset it. 

The way dti calculation works:
1) Add up your personal income  (from job)
2) Add up your personal debt payments (includes piti from personal residence - 1st and 2nd mortg)

Now calculate your net profit/loss from rental income>
Lets say you have 1 property. Take 75% of your gross rent and subtract from that your mortgage payments (1st mortg and heloc) and taxes and insurance. If its positive, then you have a net profit - add that to your personal income. If negative, then add that to your personal debt payments.

Then divide personal income and debt payments.

i.e. 3,000/mo personal debt divided by 8,000/mo personal income. = 37.5% DTI.

Now say your rent is 1,600/mo on your one property. Your PITI (incl 1st and heloc) payments are 1,000/mo. Take 75% of 1600 (1,200) and subtract 1,000. Gives you a net rental income of 200/mo.

So now your dti calc is 3,000 personal debt divided by $8,200 personal income = 36.5% DTI.

If your rental profits are good, your rental income will IMPROVE your dti - not hurt it.

The keys though are:
1) Some banks require 2 years of landlord experience before they'll count your rental income. If so, then you'd probably need to look for another bank. Most will count it right away unless you're buying 10 houses a year or something.

2) Make sure they calculate the dti this way. Some banks will try adding your 75% of rental income to the personal income side and the PITI to the personal debt side and then doing the division. Thats WRONG! But many underwriters are simply inexperienced in dealing with investor income so they'll think that makes sense. If they read the fannie mae guidelines, they'll see they're wrong.

I only mention it because I've had to deal with it on several occasions and it really does make all the difference in qualifying for the loan or not. If they calculate the dti based on the guidelines, you'll be fine with the rentals. If they don't, you wont. :-)

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  • Lauren C.Pro Member
    OP
    Rental Property Investor · Hamilton Township, NJ · Member since 2012 · 211 posts · 149 votes
    9y

    To add- I found multiple banks who will either do a 4 or 6 month seasoning for the refi which is not an issue for me as I've already owned it for 3 months.

    Thanks!

    0Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    9y

    @Lauren C., had you thought to do an FHA-approved (low deposit) Loan to begin with? (Also a 203k Rehab loan, instead of credit card?) If not, then maybe next time?

    Either way, 75% of $190k is just $142.5k, which may not be enough to completely cover your credit card debt at the same time as lowering your interest rate for the balance? (Also, Lenders might only offer 70% LTV, rather than 75%).

    Which means you likely won't have the option of taking out more than $30k, even if you wanted to?

    Congrats on making a start. You've summarized the pros and cons quite well. Lender permitting, YOU choose!...

    0Reply
  • Lauren C.Pro Member
    OP
    Rental Property Investor · Hamilton Township, NJ · Member since 2012 · 211 posts · 149 votes
    9y

    @Brent Coombs

    Thanks for the advice Brent! 

    Looking back, yes I could have/should have went with an FHA rehab loan. Since we were doing a lot of the work ourselves, I was nervous about the drawing of the money from the rehab loan and since I had most of the cash to do the rehab, I opted not to. But definitely a lesson for next time.

    The credit card debt is less than 10k so even pulling out just 30k would be enough to cover the pay off and another down payment. I've narrowed it down to two lenders and both offer 80% LTV.

    If the rate on the refi wasn't lower than my original mortgage, I think choosing the HELOC would be an easy decision.

    0Reply
  • Mike H.
    Rental Property Investor · Manteno, IL · Member since 2009 · 2k+ posts · 2k+ votes
    9y

    Since its your primary residence, you should be able to do 80% LTV so you can get a little more than that. But you're right, you would have to pay a little bit in refi costs to pull out a small amount.

    Here's why I would do it though. It sounds like you're intending to keep this as a long term rental. So pay the money and do the refi to 80%. Thats a great rate and will help your cash flow.  The advantage to doing a refi versus a heloc is that a heloc, if you were to pull out all the money would be treated as a maxed out credit card for your credit score. And yes, the bank could close the heloc out at any time. 

    That being said. If it were me and I was looking to grow a portfolio, I would keep my first mortgage and do a heloc to 90 or 95% of the ltv. Then pull out every penny of that heloc just in case the bank were to close it out.

    Ultimately, cash/capital is critical to starting out your investing. And owner occupant financing is the absolute cheapest money you're ever going to get. So get as much as you can while you can.

    If it turns out in the future, you don't need it, then you can always pay off or pay down  the heloc. What you can't do in the future is go back and get a heloc up to 90 or 95% if the home is no longer your primary residence.

    And again, there is no cheaper money that you will ever get than heloc money for a primary residence.......

    As to your side question - yes you could definitely do a cash out refi to 80% and then turn around and do a heloc to 90 or 95% (not all banks do heloc's to 90 or 95% but you can find one if you look hard enough).

    0Reply
  • Lauren C.Pro Member
    OP
    Rental Property Investor · Hamilton Township, NJ · Member since 2012 · 211 posts · 149 votes
    9y

    @Mike H. Awesome way of looking at it! 

    You are correct in assuming that I will be holding this property for a while. 

    In regards to choosing the HELOC because money is cheaper on a primary residence, the next property I buy will most likely be my next/new primary residence (another small multi) in which I can rehab and do a HELOC on that one.

    Can a person have two HELOCs? For example, if I do a HELOC on this property and then move to another in a year or so, can I not do a HELOC on the second, and at the time, current primary residence?

    If not, then wouldn't it be better to do a cash out refi on this current property and then HELOC the second?

    Just trying to fully understand all of the options. Thanks!

    0Reply
  • Brad Crosby
    Lender · Ogden, UT · Member since 2016 · 9 posts · 4 votes
    9y
    Yes you can have multiple HELOCs at a time as long as you can qualify for them. When applying for the new HELOC most banks will base the payment for your existing HELOC off the maximum loan amount regardless of whether you've pulled the money out or not so keep that in mind, it may throw off your DTI.
    0Reply
  • Mike H.
    Rental Property Investor · Manteno, IL · Member since 2009 · 2k+ posts · 2k+ votes
    9y

    Therein lies the value of the house hack. Keep buying properties as your primary residence so you can get the cheaper financing as you grow your portfolio. And yes, I believe you can get heloc's for each house.

    That being said, there can be a limit for some banks on how many mortgaged properties you can have in order to qualify for their heloc. So even though fannie mae allows up to 10 financed properties, that is for first mortgages only. Some banks might not do heloc's once you have 4 or more mortgaged properties - even if it is your primary residence.

    But again, some will. Just keep shopping around.

    It is the cheapest money you're going to get. And if it gets to where you make a decision that you aren't going to need it, then pay them off and close them out.

    In terms of credit and dti qualifications, that is definitely a consideration when it comes to heloc's. But as a landlord you should be able to use your rental income (or a portion thereof) against the payments to offset it. 

    The way dti calculation works:
    1) Add up your personal income  (from job)
    2) Add up your personal debt payments (includes piti from personal residence - 1st and 2nd mortg)

    Now calculate your net profit/loss from rental income>
    Lets say you have 1 property. Take 75% of your gross rent and subtract from that your mortgage payments (1st mortg and heloc) and taxes and insurance. If its positive, then you have a net profit - add that to your personal income. If negative, then add that to your personal debt payments.

    Then divide personal income and debt payments.

    i.e. 3,000/mo personal debt divided by 8,000/mo personal income. = 37.5% DTI.

    Now say your rent is 1,600/mo on your one property. Your PITI (incl 1st and heloc) payments are 1,000/mo. Take 75% of 1600 (1,200) and subtract 1,000. Gives you a net rental income of 200/mo.

    So now your dti calc is 3,000 personal debt divided by $8,200 personal income = 36.5% DTI.

    If your rental profits are good, your rental income will IMPROVE your dti - not hurt it.

    The keys though are:
    1) Some banks require 2 years of landlord experience before they'll count your rental income. If so, then you'd probably need to look for another bank. Most will count it right away unless you're buying 10 houses a year or something.

    2) Make sure they calculate the dti this way. Some banks will try adding your 75% of rental income to the personal income side and the PITI to the personal debt side and then doing the division. Thats WRONG! But many underwriters are simply inexperienced in dealing with investor income so they'll think that makes sense. If they read the fannie mae guidelines, they'll see they're wrong.

    I only mention it because I've had to deal with it on several occasions and it really does make all the difference in qualifying for the loan or not. If they calculate the dti based on the guidelines, you'll be fine with the rentals. If they don't, you wont. :-)

    2Reply
  • Lauren C.Pro Member
    OP
    Rental Property Investor · Hamilton Township, NJ · Member since 2012 · 211 posts · 149 votes
    9y

    @Mike Cumbie I didn't even think of DTI in terms of this decision. Thanks for bringing it up!

    @Mike H. Wow thanks for all of this. I didn't realize that the amount of mortgages would effect the HELOCs.

    And thank you so much for such a detailed explanation of how to calculate DTI. That was super helpful and I'll remember to ensure the underwriters calculate it correctly as well.

    1Reply
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