HELOC or Home Equity Fixed Rate Loan

[Jerome Morelos]

I'm debating on whether to use a HELOC or a Home Equity Fixed Rate Loan to finance a garage conversion ADU. I am in the process of getting bids for the 350 sq ft garage conversion ADU, but I'm expecting 70-85k. Could rent it for $1,500. What are your thoughts on my 3 options below:

1) Use a HELOC to finance a garage conversion ADU. Use the cash flow from that + my W-2 income to save up for another value-add, owner-occupy property. As soon as there's enough equity, refinance and pay off the HELOC on the first. Issue of course is the ARM on the HELOC, but I get the flexibility and interest-only payment option.

2) Use a Home Equity Fixed Rate Loan to finance a garage conversion ADU. and repeat the process in option 1. The interest rate will be higher than the HELOC, but with the peace of mind of a fixed rate. I've gotten quotes of 7.35%, term 20 years. I also won't have the flexibility of the HELOC and will be required to pay P+I on the lump sump borrowed from the gecko.

3) Hold off on the garage conversion ADU and use a HELOC to acquire my 2nd value-add property instead. The opportunity cost would be the cash flow from the ADU. This is all in SoCal, so that cash flow would be nice.

[Trevor Alexander]

Hi Jerome -- HELOC's are typically best as short term loans due to the variable rate, and for smaller amounts borrowed (say, under $100,000).

If the HELOC will be paid off in a few years, I'd probably do a HELOC. If you'll have the loan long term (say, 5+ years), I would probably recommend Home Equity Loan, or Cash-out Refinance. Looks like your cash flow on the Home Equity Loan would be good at $823 per month (P&I on $85,000 at 7.35% rate for 20 years is $677).

You'll have even higher cash flow on a cash-out refinance because you can do a 30 year term, and the rate for no points most likely in the 6% range.

Last thing....the thing I like about HELOC's is the ability to take out a line for let's say $150,000, but if you only use 75K of it, you only pay interest on that amount and the rest sits there as a security net. HELOC or cash-out refinance, you are paying principal/interest on the entire amount.

Hope that helps!