Using the HELOC strategy to buy rentals

OP

Denver, CO · Member since 2017 · 142 posts · 104 votes

8y

Originally posted by @Ryan Weirick:

From my understanding a HELOC is still tax deductible if it is being used to buy rentals. It isn't deductible of you are using it to pay off credit card debt or to renovate your primary residence.

Wow, that is great news then!

OP

Denver, CO · Member since 2017 · 142 posts · 104 votes

8y

Originally posted by @Sam B.:

Why continue to use variable rate non deductible heloc money when you can cash out refi your rentals, have 30 years to pay the loan, lock in a fixed low rate, and deduct the interest?

> My other dilemma is if I buy the rentals in an LLC, and use the cash flow to pay off the personal HELOC, what issues am I getting into? Should I even put them in an LLC?

You won't be able to refi using a conventional loan if the property is owned by an LLC.

From what I've read, the simple interest on a HELOC will get paid much faster than a conventional mortgage. The higher rate in this case, is not so much a negative. Plus, as soon as I pay down the HELOC, I have access the spend that cash again.

I did not know that about the LLC/conventional loan. So how does everyone do it? Commercial loans?

Sam B.

Investor · Indianapolis, IN · Member since 2015 · 270 posts · 217 votes

8y

Originally posted by @Alex Corral:

Originally posted by @Sam B.:

Why continue to use variable rate non deductible heloc money when you can cash out refi your rentals, have 30 years to pay the loan, lock in a fixed low rate, and deduct the interest?

> My other dilemma is if I buy the rentals in an LLC, and use the cash flow to pay off the personal HELOC, what issues am I getting into? Should I even put them in an LLC?

You won't be able to refi using a conventional loan if the property is owned by an LLC.

From what I've read, the simple interest on a HELOC will get paid much faster than a conventional mortgage. The higher rate in this case, is not so much a negative. Plus, as soon as I pay down the HELOC, I have access the spend that cash again.

I did not know that about the LLC/conventional loan. So how does everyone do it? Commercial loans?

Only because of the amortization period. You always have the option to prepay principal on your loan. A conventional loan is going to be more cost effective in 9/10 cases. Borrowing on equal terms, a HELOC will be more expensive if rates go up at all.

Plenty of people do not hold their properties in LLCs. If they do, they pay cash or get commercial loans at higher/variable rates and shorter amortization periods.

Originally posted by @Alex Corral:

Originally posted by @Ryan Weirick:

From my understanding a HELOC is still tax deductible if it is being used to buy rentals. It isn't deductible of you are using it to pay off credit card debt or to renovate your primary residence.

Wow, that is great news then!

Don't think that's the case.

Christopher Giannino

Real Estate Agent · Hamilton, NJ · Member since 2013 · 464 posts · 311 votes

8y

I too am interested in getting a HELOC on my primary to help fund future real estate deals but the only problem is that in my opinion, HELOCs are currently only good solutions for the short-term. We are in an environment where interest rates are rising so in a situation where it takes you years to pay off the original draw for investments, it could potentially be troublesome. Let's say you take out a significant amount of money to fund a couple deals at 4% interest, since it's a variable rate, it will go up as the rates increase. In a year or two, you could be easily paying over 5.5% interest for that money. With mortgage rates still low, you could probably easily lock in a mortgage for under that 5.5%.

If you want more aggressive offers use the HELOC to purchase a property as cash and then simply look to do a cash-out refinance after the loan is seasoned and use that refinance money to pay off the HELCO, then repeat. Look up the BRRRR strategy here on BP. Definitely do your due diligence regarding the matter first because its more involved then how I just explained. Best of luck!

2 Reply

OP

Denver, CO · Member since 2017 · 142 posts · 104 votes

8y

Thanks for the info. I know the HELOC debate is still out, but from the research I've done, it seems that that type of loan will be paid off faster. So, even if the rate does increase, it will still be cheaper to pay it on a HELOC. There are tons of threads about it here on BP. Seems to be split though. Wish I had seen this sooner since Prime has not changed the last 10 years, until recently.

James W.

Minneapolis, MN · Member since 2017 · 353 posts · 223 votes

8y

I've used HELOCs in the past and won't do it again if I can get conventional financing or if I am sure I am only doing a deal for a short period of time. As stated before, the amortization periods are shorter (usually 15 years after a 5 year draw period) and this hurts your cash flow when in repayment. The variable rate could cost you over time as well depending on how interest rates go.

If you are planning on keeping this money for investment use long term, why not just refi your residence on a new conventional loan and lock in the cost of your funding source? You can always prepay the mortgage if you like.

Christopher Giannino

Real Estate Agent · Hamilton, NJ · Member since 2013 · 464 posts · 311 votes

8y

@Alex Corral so is your ultimate goal to own properties free and clear?

OP

Denver, CO · Member since 2017 · 142 posts · 104 votes

8y

@Christopher Giannino

Yes, as hotly debated as it is, lol. I just feel, the savings in the interest combined with much higher cash flow are why I want to pay them off faster. I know it's not everyone's strategy though.

Christopher Giannino

Real Estate Agent · Hamilton, NJ · Member since 2013 · 464 posts · 311 votes

8y

@Alex Corral Hey there's nothing wrong with that strategy if it works for you.. Everyone's strategy is different but as long as you can achieve what you want in the end, it really doesn't matter how you got there. So are you talking about using the HELOC as a "sweep account."

OP

Denver, CO · Member since 2017 · 142 posts · 104 votes

8y

Christopher Giannino Not really a "sweep account", but mainly to have access to more cash as soon as I pay it down. Basically also use it to get 100% financing, instead of using my cash reserves.

James W.

Minneapolis, MN · Member since 2017 · 353 posts · 223 votes

8y

Originally posted by @Alex Corral:

Christopher Giannino

Not really a "sweep account", but mainly to have access to more cash as soon as I pay it down. Basically also use it to get 100% financing, instead of using my cash reserves.

It works fine for that until you are at the end of your draw period. At that point, you simply have a adjustable rate loan for the balance unless you could refinance it into a new HELOC. I haven't seen a HELOC with a draw period greater than 5 years.

OP

Denver, CO · Member since 2017 · 142 posts · 104 votes

8y

@James W. That is odd. I've called about 15 banks & CU. All have 10 year draw & 20 year amortization.

John Woodrich

Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes

8y

Originally posted by @Alex Corral:

@James W. That is odd. I've called about 15 banks & CU. All have 10 year draw & 20 year amortization.

The typical draw period for a HELOC is going to be half of the term. So a 15 year will generally have a 7-8 year draw period. If you can get a 20 year a 10 year period may be attainable. Haven't heard of them in my area but I don't call 15 banks looking for a single loan :)

Source - I have a 15 year HELOC, draw period is over, balance $80k, 3.25% interest, monthly payment $1140! Yes, going to refi soon.

John Woodrich

Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes

8y

To answer other questions - the HELOC interest would not be deductible on your Schedule-A however the interest tracing rules would likely allow you to use the interest to offset rental income on the properties purchased.

If you purchase these in LLCs (good idea as it sounds like you have some net worth) your payments on the HELOC would simply be a distribution. Couple of accounting transactions but otherwise no issues.

2 Reply

Joe SplitrockPro Member

Moderator

Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes

8y

@Alex Corral there is lots of mis-informaiton about HELOC interest in the forums. I have participated in discussions around this and the split is between people who understand how interest works and people who don't.

Interest accrued on a HELOC and fixed rate mortgage is calculated the same and is based on the outstanding balance and interest rate. In other words, if I took out a HELOC for $100,000 at 4% and paid monthly even payments over 30 years, it would be the same as a 30 year fixed rate mortgage at 4%.

The only way to pay off the loan faster is by paying more principal. If you applied the same principal payments to a 30 year fixed rate mortgage as you did your HELOC, it would pay off just as fast. In the comparisons I have done, usually the HELOC takes longer and you pay more interest, because of the higher interest rate on the HELOC.

The advantage of the HELOC as a "savings account" is that all your capital goes immediately towards principal pay down. People find it easier than making extra principal payments on a mortgage. The other consideration is that once you make a principal payment to a mortgage, the cash is gone towards equity. With a HELOC you can just take the money back out if you need it.

I like your strategy of using the HELOC to make cash offers. In today's competitive environment, that gives you and advantage. I would refinance the properties into 30 year fixed rate mortgages to lock in low interest rates. Your HELOC is variable and the way the FED is raising rates, you will be stuck paying 1-2% more interest in a year or two. You are better off locking in the low fixed mortgage rates and making extra principal payments.

6 Reply

OP

Denver, CO · Member since 2017 · 142 posts · 104 votes

8y

Originally posted by @John Woodrich:

Originally posted by @Alex Corral:

@James W. That is odd. I've called about 15 banks & CU. All have 10 year draw & 20 year amortization.

The typical draw period for a HELOC is going to be half of the term. So a 15 year will generally have a 7-8 year draw period. If you can get a 20 year a 10 year period may be attainable. Haven't heard of them in my area but I don't call 15 banks looking for a single loan :)

Source - I have a 15 year HELOC, draw period is over, balance $80k, 3.25% interest, monthly payment $1140! Yes, going to refi soon.

Haha.. Due diligence. :)

From US Bank site "A Home Equity Line of Credit has 2 different periods, a draw period and repayment period. The draw period is 10 years, where you have ongoing access to available funds and can use the funds how you'd like."

BOA, and a lot of CUs, have the same draw info online.

3.25% is a pretty good rate.

John Woodrich

Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes

8y

Haha.. Due diligence. :)

From US Bank site "A Home Equity Line of Credit has 2 different periods, a draw period and repayment period. The draw period is 10 years, where you have ongoing access to available funds and can use the funds how you'd like."

BOA, and a lot of CUs, have the same draw info online.

3.25% is a pretty good rate.

I suspect the 10 year draw period is on a 20 year HELOC. My 3.25% is an older loan from a Credit Union and unfortunately my draw period is over so I just have high payments.

OP

Denver, CO · Member since 2017 · 142 posts · 104 votes

8y

Originally posted by @Joe Splitrock:

@Alex Corral there is lots of mis-informaiton about HELOC interest in the forums. I have participated in discussions around this and the split is between people who understand how interest works and people who don't.

Interest accrued on a HELOC and fixed rate mortgage is calculated the same and is based on the outstanding balance and interest rate. In other words, if I took out a HELOC for $100,000 at 4% and paid monthly even payments over 30 years, it would be the same as a 30 year fixed rate mortgage at 4%.

The only way to pay off the loan faster is by paying more principal. If you applied the same principal payments to a 30 year fixed rate mortgage as you did your HELOC, it would pay off just as fast. In the comparisons I have done, usually the HELOC takes longer and you pay more interest, because of the higher interest rate on the HELOC.

The advantage of the HELOC as a "savings account" is that all your capital goes immediately towards principal pay down. People find it easier than making extra principal payments on a mortgage. The other consideration is that once you make a principal payment to a mortgage, the cash is gone towards equity. With a HELOC you can just take the money back out if you need it.

I like your strategy of using the HELOC to make cash offers. In today's competitive environment, that gives you and advantage. I would refinance the properties into 30 year fixed rate mortgages to lock in low interest rates. Your HELOC is variable and the way the FED is raising rates, you will be stuck paying 1-2% more interest in a year or two. You are better off locking in the low fixed mortgage rates and making extra principal payments.

Hi Joe, I totally agree with you. I've read many threads and am about 9 pages in on that crazy long discussion you were in :)

I have been trying to be real careful about the different in interest. Seems odd, but I've been told that it is like credit card interest. I made an excel spreadsheet, and my calculations were better on the HELOC, but again, I'm not 100% sure. The main benefit I see, is being able to re-use that HELOC for a sudden repair, if needed. The CON, is that the rates are finally starting to creep, and with how the economy has been, I think it will keep rising. Tough choice.

David W.

Investor · Laguna Niguel, CA · Member since 2014 · 16 posts · 9 votes

8y

I'm in year 5 using a HELOC on my primary residence to acquire and renovate buy and holds. I have a 180k line, the rate is 4.99% interest only, 10 year draw. I've run the balance up as high as 150k and back to below zero multiple times in 5 years. I use it as a checking account, all rental cash flow including reserves and property tax withholding to paydown principle. I draw from the HELOC to pay property taxes and major repairs. In addition, I pay down principle with "savings" income from my W2.

This week I'm chatting with lenders, a new HELOC with similar terms and 1% lower APR. Right now my balance is near zero and I'm ready to make a cash offer on the next opportunity.

7 Reply

Joe SplitrockPro Member

Moderator

Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes

8y

Originally posted by @Alex Corral:

Originally posted by @Joe Splitrock:

@Alex Corral there is lots of mis-informaiton about HELOC interest in the forums. I have participated in discussions around this and the split is between people who understand how interest works and people who don't.

Interest accrued on a HELOC and fixed rate mortgage is calculated the same and is based on the outstanding balance and interest rate. In other words, if I took out a HELOC for $100,000 at 4% and paid monthly even payments over 30 years, it would be the same as a 30 year fixed rate mortgage at 4%.

The only way to pay off the loan faster is by paying more principal. If you applied the same principal payments to a 30 year fixed rate mortgage as you did your HELOC, it would pay off just as fast. In the comparisons I have done, usually the HELOC takes longer and you pay more interest, because of the higher interest rate on the HELOC.

The advantage of the HELOC as a "savings account" is that all your capital goes immediately towards principal pay down. People find it easier than making extra principal payments on a mortgage. The other consideration is that once you make a principal payment to a mortgage, the cash is gone towards equity. With a HELOC you can just take the money back out if you need it.

I like your strategy of using the HELOC to make cash offers. In today's competitive environment, that gives you and advantage. I would refinance the properties into 30 year fixed rate mortgages to lock in low interest rates. Your HELOC is variable and the way the FED is raising rates, you will be stuck paying 1-2% more interest in a year or two. You are better off locking in the low fixed mortgage rates and making extra principal payments.

Hi Joe, I totally agree with you. I've read many threads and am about 9 pages in on that crazy long discussion you were in :)

I have been trying to be real careful about the different in interest. Seems odd, but I've been told that it is like credit card interest. I made an excel spreadsheet, and my calculations were better on the HELOC, but again, I'm not 100% sure. The main benefit I see, is being able to re-use that HELOC for a sudden repair, if needed. The CON, is that the rates are finally starting to creep, and with how the economy has been, I think it will keep rising. Tough choice.

Ahh yes, my favorite BP discussion of all time. The problem there was we were debating a changing argument. You can pay off a mortgage faster using a HELOC, but you can also pay off a fixed rate mortgage in the same time if you use the same principal payments. Usually when people compare the two, the difference is making extra payments on the HELOC and not making them on the fixed mortgage. Without seeing your spreadsheet, it is hard to say why your HELOC is coming out better. I can assure you if the interest amount and all the principal payments are the same, there is little difference. Both types of loans recalculate the interest as you pay down principal. If I recall there is a minor difference on when this occurs within the month, but it doesn't translate to anything significant in the end. It is discussed in the thread.

The only benefit is being is being able to re-use the HELOC. The disadvantage is a higher interest rate, which is a major concern in the coming years. The FED has stated they WILL keep raising rates. If it takes you years to pay this off, you could end up paying significantly more over time.

Here is another approach. Use the HELOC to purchase, then refinance into 30 year fixed rate. Every month, take all your extra cash and put it towards paying off one of the mortgages as an extra principal payment. If you need money, your HELOC is open with $0 balance on it. You can take advantage of low, fixed rates and have a ready line of credit. Best of both worlds.

4 Reply

OP

Denver, CO · Member since 2017 · 142 posts · 104 votes

8y

@Joe Splitrock that is my plan A2 :) I still prefer my original plan, because if I'm doing it right, I can save on the closing costs required for a mortgage.

Here's my spread sheet. I have an extra $1700 a month left over in income. And if I buy 3 rentals that will net $2000 a month, I would pay $3700 into the $200k HELOC balance at a 5.5% rate. I won't have money going to savings, but that's ok because I should be saving a lot in interest, and still have access to cash via the HELOC.

I'm still learning, so let me know if I made a mistake.

I need to run a spreadsheet paying the extra $1700 + net rent from that property, to compare exactly. So, If I bought 3 rentals with 3 mortgages, I would have to pay their net rent after debt service, + $567. Again, the con is I'm basically broke trying to pay down those mortgages only to have the money sitting as equity.

Joe SplitrockPro Member

Moderator

Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes

8y

Originally posted by @Alex Corral:

@Joe Splitrock that is my plan A2 :) I still prefer my original plan, because if I'm doing it right, I can save on the closing costs required for a mortgage.

Here's my spread sheet. I have an extra $1700 a month left over in income. And if I buy 3 rentals that will net $2000 a month, I would pay $3700 into the $200k HELOC balance at a 5.5% rate. I won't have money going to savings, but that's ok because I should be saving a lot in interest, and still have access to cash via the HELOC.

I'm still learning, so let me know if I made a mistake.

I need to run a spreadsheet paying the extra $1700 + net rent from that property, to compare exactly. So, If I bought 3 rentals with 3 mortgages, I would have to pay their net rent after debt service, + $567. Again, the con is I'm basically broke trying to pay down those mortgages only to have the money sitting as equity.

I don't think there is a problem with your spreadsheet. I just went to a fixed rate mortgage calculator and punched in $200,000 at 5.5% and term of 63 months. The payment would be $3662.18 for 63 months and total repaid is $230,717.50. If you change the rate to 4.5%, it saves around $5000 worth of interest.

Obviously there is no option for 63 month fixed rate mortgage, but even if you take out a 30 year mortgage, then pay $3662.18 per month, the loan will be paid off in 63 months with $230,717 paid back. On a 30 year fixed, the payment would be $1135.58, so you would be required to pay that minimum, which is well under your $2000 rent. When you pay the extra principal, you just accelerate the 30 year and turn it into a 63 month loan.

I hear what you are saying on closing costs, but I still think there is higher risk of rate fluctuation. Each percentage point of interest is going to cost you roughly $5000, so you have to decide what the risk is.

As far as your last comment about being broke paying down the mortgages with money stuck as equity, that is not really the case. Since you still have the HELOC, you have access to even more money. You could even float the payment each month from your HELOC, so if your spending is higher one month, you just have a little balance on the HELOC until the next month.

2 Reply

Gerard Charles

Rental Property Investor · Austin, TX · Member since 2011 · 30 posts · 5 votes

8y

What about if you use heloc as a down payment you buy a duplex , live in one and rent the other. It will be my primary resident but will be renting the side. Will it still consider tax deductible ?