I'm trying to learn about rental property equity financing. But all the articles I find are about using equity in your HOME to buy a second property or rental property. But what about using home equity in your rental property to buy a new primary home?
Since 2015 I've had a rental unit in Virginia while I lived in CA. I sold my house in CA and am moving back to VA. I don't want to live in my condo so I'm going to buy a new home. I am looking into all my options to include possibly using the equity in my condo to assist in buying the home I want. I know the difference between a cash out refinance vs HEL vs HELOC. But I don't know the particulars and advantages/disadvantages for those options in regards to using it on a rental property, especially during this time with the pandemic and all the new lender requirements. Any insight would be greatly appreciated!
If you need numbers, my mortgage balance for my rental property is $143k and the estimated value is $220k.
Many lenders don't do HELOCs on investment properties, but some do. Assuming typical financing ratios on investment properties, you're capped at 75% LTV, which would allow you to cash out up to $22K ($220K * .75 = $165K - current balance of $143K = $22K cash out poss; some only lend to 70% LTV which would only net you about $11K). If you can find a lender who does NOO/Investment HELOCs, that may be the way to go. You would poss pay a higher interest rate, but generally no closing costs. Being a relatively small balance the difference in interest rate and ability to pay it off sooner may negate the downside to the higher rate (typically tied to prime rate).
Another option is a cashout refi of the rental property/condo. You did not mention the terms of your current loan (rate, how many years into the loan, current payment amount, etc), but cashout refi on Inv properties can get costly on the fees. Aimloan.com has a great pricing quote system that doesn't require any personal info to be submitted. I just checked that site, with 760+ credit score, $165K loan, 30 year fixed, $4502 in fees/closing costs, at 4.125%, payment of $799.67. In this scenario, you would be paying about $4500 (plus interest) to borrow $22K, netting approx $17,500 (fee analysis is 25.7% up front cost to borrow $17,500; plus regular interest).
For the above scenario reasons, I suggest a HELOC if its an option. If however your current loan has some crazy high interest rate, or some other reason you were going to refi anyways, then you might consider paying the $4500 and refi.
As far as lender requirements, they are pretty standard DTI 45% generally, and you'll probably have to show up to 6mo cash reserves for the loan. In general, if the property cashflows for you, and you will still cashflow with the new loan, and you have decent credit, W2 income, etc you should be fine with either refi or HELOC.
Many lenders don't do HELOCs on investment properties, but some do. Assuming typical financing ratios on investment properties, you're capped at 75% LTV, which would allow you to cash out up to $22K ($220K * .75 = $165K - current balance of $143K = $22K cash out poss; some only lend to 70% LTV which would only net you about $11K). If you can find a lender who does NOO/Investment HELOCs, that may be the way to go. You would poss pay a higher interest rate, but generally no closing costs. Being a relatively small balance the difference in interest rate and ability to pay it off sooner may negate the downside to the higher rate (typically tied to prime rate).
Another option is a cashout refi of the rental property/condo. You did not mention the terms of your current loan (rate, how many years into the loan, current payment amount, etc), but cashout refi on Inv properties can get costly on the fees. Aimloan.com has a great pricing quote system that doesn't require any personal info to be submitted. I just checked that site, with 760+ credit score, $165K loan, 30 year fixed, $4502 in fees/closing costs, at 4.125%, payment of $799.67. In this scenario, you would be paying about $4500 (plus interest) to borrow $22K, netting approx $17,500 (fee analysis is 25.7% up front cost to borrow $17,500; plus regular interest).
For the above scenario reasons, I suggest a HELOC if its an option. If however your current loan has some crazy high interest rate, or some other reason you were going to refi anyways, then you might consider paying the $4500 and refi.
As far as lender requirements, they are pretty standard DTI 45% generally, and you'll probably have to show up to 6mo cash reserves for the loan. In general, if the property cashflows for you, and you will still cashflow with the new loan, and you have decent credit, W2 income, etc you should be fine with either refi or HELOC.
Wow thanks so much Andrew. Your reply nailed it. It was exactly the type of information I was looking for. My rate for my rental mortgage is 4.25% and I'm 7 years into the mortgage with a $1034/mo payment. I also thought like you in that the rate wasn't high enough to justify a refi and paying all those fees. I didn't know about the 6mo of cash reserves so that's interesting. It is amazing how I have about $80k in equity but due to all the lender rules/requirements/fees it seems like I'm barely getting anything.
Thanks, glad to help. The good news is it is still building equity and hopefully cashflow. Most people in general know about ROI/Return on Investment. One thing to also consider is your ROE/Return on Equity, which typically tends to diminish over time as your equity grows. So if you have $80K equity now, and say the principal balance on your loan gets paid down $3K+/year, next year (assuming no valuation appreciation or depreciation) you will have $83K in equity.
Basically ROE is your opportunity cost. That is, how else could you invest that $83K to get a larger return/ROI? So instead of only looking at how much return/ROI you get out of your cash invested, you may consider what are your other options for that $80K. "If I sold, and after closing costs, maybe net $75K (simple round math), how else could I invest that $75K to get a larger return?"
If you can put down $35K each on two new purchases of $140K and pay a total of $5K in closing costs, you have $70K equity, but maybe a higher ROI than the one condo produced; maybe not though. If the condo is only producing $300/mo, but your reallocation with new assests produces $300/mo each, you have essentially doubled your cash-on-cash rate of return. (9% on $80K vs 4.5%).
Food for thought, like an under performing stock, all assets should be evaluated. Yours may be performing well, I’m not saying it doesn’t, just thoughts to provoke some analysis. There’s also potential tax implications (capital gains taxes, etc), but the basics hold true to analyze your best return and options.
Also consider another adage, that you should invest where the money makes sense, and buy OR RENT where you want to live. If you have the option to live in an oceanfront/beachfront home for say $5,000/month, but that home would cost you $10,000/mo to buy, maybe you are better off with a long term tenancy and invest the other $5,000/mo. Big numbers in that hypothetical but the logic makes sense.
Andrew
Oh yeah, another thought, if monthly cash flow is not an issue, and $22K will make a difference toward your new purchase, assuming you have a car or two paid off (or low balance owed), consider doing a cashout refinance of your auto loan(s). Many times auto loans are the source of some of the cheapest borrowing you can do. Fixed rates, and right now you can easily get 3-4% for late model cars.
A few years ago I had 3 cars paid off (don’t generally like or carry any consumer debt), so I did cashout loans on them and sourced about $50K cash on them at like 3-4%. Great way to get cash for investing. That $50K got me into additional properties making way more than 4%.
Food for thought.
Andrew