Investor · Phoenix, AZ · Member since 2018 · 420 posts · 388 votes
Here is the scenario. I have a home that I’ve owned for 6 years. It’s worth about $380k and I owe about $240k. I want to strip out as much equity as possible. Today a wild idea occurred to me and I want to consult the community. But first the traditional options and why I don’t like them.
1. Refinance - This would require 80% LTV and only allow me to strip about $64,000. Also requires closing costs.
2. HELOC - same as above with a higher interest rate and an additional monthly payment on the borrow. Also requires closing costs.
Now for my wild idea...
3. Sell to myself - If I buy the house from myself using an FHA loan @3.5% down I'll pay about $13k plus closing costs. I'll get the tax exemption having lived in it for 2 of the past 5 years along with a new basis of $380k. Most importantly, I'll clear about $140k on the sell side with $13k plus closing going back in for a net of $127k. I realize I'll pay PMI and my monthly cost will go up..but putting an extra $63k in my pocket in the middle of a pandemic seems like the move.
Assuming that you have the property titled in an LLC currently, I don't think this will work since you are the Member of the selling entity. If its titled in your personal name, it would just be a refinance.
I would try to find a friend or family member who has an under performing IRA or has money in a bank CD. Give them a 2nd mortgage in exchange for your equity. You get the cash, they get a safe stable investment, and it never appears on your credit.
@Kerri K. A HELOC is a way to use the equity in a property so you have readily available money. It should be used just like cash.. typically only temporarily until you can do a refinance. The payments on a HELOC are typically higher than a traditional loan (usually 1% per month of the outstanding loan balance). It doesn't mean the money is more expensive, it just constricts cash flow until you can get long-term financing.
Feel free to message if you have additional questions - this thread has exploded.
@Account Closed Except if you refinance ALL of your equity out of this property you will be paying interest on it, immediately. If you utilize a HELOC you'd have cash ready that you aren't paying interest on. You only start paying interest if you deploy the money. Paying interest on money sitting in a bank losing money doesn't make any sense to me. You are basically getting a negative return (the interest rate + inflation rate) on that money so you can feel like you have a backstop.
I'm with @Preston Porter. The heloc seems like the simplest and easiest depending on what you have geared up for that cash. If it's simply just to have liquidity then why pay interest on it, let it sit un-drawn. And you mentioned closing costs being a deterrent in the Heloc option... consider shopping lenders.... I paid less than $300 in fees on my heloc. Lender waived much of the other fees (like appraisal) so long as I keep the heloc open for at least 3 years.
@Preston Porter sure. But the HELOC does nothing for me in the event the underlying asset tanks unless it's fully drawn out prior to. It is not a protection against downside risk.
Why, "But theHELOC does nothing for me in the event the underlying asset tanks unless it's fully drawn out prior to. It is not a protection against downside risk." ?
What does the future value of the asset have anything to do with being able to draw out funds?
@Account Closed I went through a similar process in my head about a property I have in Tacoma. As everyone else has mentioned, probablly not going to work. The best option I found was a local CU who offered 90% LTV on a 5/5 ARM for a refinance. Have you explored local banks or CU's? I think the rates there were like +1% over prime or something but it gives you that extra 10%. You might even be able to find someone to loan the next 5% on a HELOC if you're lucky. Best of luck.
@David M. because a HELOC is subject to the value of the asset. If that value falls, you no longer have equity. The line of credit is reduced in turn. Lending institutions won't lend against equity you don't have.
I guess hloc's have changed since i last got one. It used to be like any other loan. At the time you want to close, they give you a credit of so much in accordance with your property's value. Then, the credit line is fixed as its recorded in the lien and the Note. Its the same as your mortgage... Just because you are underwater the Note holder doesn't call in the excess, or start charging PMI because the ltv may have dropped...
@David M. My experience with helocs is the same as yours. Market could tank tomorrow and the value market value of my assets cut in half. I’d still have full access to the heloc until it’s maturity.
Right. same "bad" thing that happened to many homeowners during the 2007-2008 crash which created so many short sales, etc... I guess OP's 4 years of investing and however number of years as a real estate agent hasn't experienced enough.
The very nature of a HELOC is such that the point when you need liquidity the most, is the same exact moment that you have as little access to it as possible.
In 2008 HELOCs were frozen/reduced/called due. Credit card limits were reduced by 95%. Credit was all but extinct. Values of homes were cut in half or worse. And if you were lucky enough to keep your job, and *silly* enough to keep paying for your house...you got caught holding the bag. Those that survived has massive liquidity. I want to be in that boat at all times. PSA: I’m not expecting a crash, but I am protecting against one.
The only protection against that scenario is cold hard cash.
The option to give you the most equity possible is obviously selling the property, but I understand you may not want to do that. But that option will answer your question. 2nd best is cash out refinance since you want the reserves without collateral ties.
The very nature of a HELOC is such that the point when you need liquidity the most, is the same exact moment that you have as little access to it as possible.
In 2008 HELOCs were frozen/reduced/called due. Credit card limits were reduced by 95%. Credit was all but extinct. Values of homes were cut in half or worse. And if you were lucky enough to keep your job, and *silly* enough to keep paying for your house...you got caught holding the bag. Those that survived has massive liquidity. I want to be in that boat at all times. PSA: I’m not expecting a crash, but I am protecting against one.
The only protection against that scenario is cold hard cash.
If you don't believe me personally based on a "4 year investing history"....here's a link to it happening in real time to someone on BP.
I think your logic is flawed here. Why would you want to be over leveraged if there is a major market event that drastically decreases the value of the property? I understand wanting to have liquidity in the event of a market crash to potentially buy more deals, but doing so at the cost of putting yourself into a massive negative equity situation seems bizarre.
Your other plan to "limit downside risk" is to cash out by selling to a family member at what you're expecting to be the height of the market and then sticking said family member with a property that they are underwater in debt with? I'd consider that highly unethical on top of walking the line of mortgage fraud.
With a HELOC, they aren't going to actively re-appraise your property and change your available credit limit before the term is over. There is a chance that if there is a major credit market crash they may freeze your ability to draw from the line, but I don't suspect the loan would be called due unless you were in poor standing.
So you are trying to avoid a specific crisis, a mortgage / lending one. One that may never happen again in your lifetime, or at least the life of your loan. Interesting... You know that not all of the hloc's were affected...
Do what you want to do. The reality is the more complicated your setup, the bigger the risk of a problem/issue later on. Meanwhile, you are chasing one principal (ie "cash is king") by sacrificing another (i.e. regarding leverage).
@James Maradits In the event the underlying asset tanks, a HELOC that I haven't drawn on gets reduced. A HELOC that I have drawn fully out only allowed me to pay additional interest (more than a traditional refi) on money that was sitting in reserves during the draw period. This does nothing to protect my downside risk in the event values were to take a massive hit. Nobody draws out $80k on a HELOC to let it sit on the sidelines at 4.5% interest unless they are nuts.
As @Matthew Olszak suggested....if I were to rent to a family member for 6 months and then sell it to said family member I get all the downside protection with a fraction of the skin in the game. If my family member were to purchase the house from me with 3.5% down and the asset values crash 6 months later I'm sitting on $120k in cash. My family member gets a FHA loan at ideal interest rates, a new basis for depreciation, and after one year he could take me on as a tenant paying our way out of the crash. Everyone wins.
A HELOC is the convenient answer...and in my opinion... the wrong one to limit downside risk.
I think your logic is flawed here. Why would you want to be over leveraged if there is a major market event that drastically decreases the value of the property? I understand wanting to have liquidity in the event of a market crash to potentially buy more deals, but doing so at the cost of putting yourself into a massive negative equity situation seems bizarre.
Your other plan to "limit downside risk" is to cash out by selling to a family member at what you're expecting to be the height of the market and then sticking said family member with a property that they are underwater in debt with? I'd consider that highly unethical on top of walking the line of mortgage fraud.
With a HELOC, they aren't going to actively re-appraise your property and change your available credit limit before the term is over. There is a chance that if there is a major credit market crash they may freeze your ability to draw from the line, but I don't suspect the loan would be called due unless you were in poor standing.
Where did you get "over leveraged?" We are talking about ONE house that I own, not my entire portfolio.
Where did you "height of the market"? I am talking about selling now because I'm in a position to strip equity. I'm not trying to time the market.
Where did you get "sticking said family member" when I mentioned renting the place back from said family member, giving them all the tax benefits of depreciation, and a rock solid tenant in myself with $120k in cash to pull through the downturn.
Where did you get "unethical" or "fraud" when I mentioned selling a property I own to someone I know, having them occupy for a year under the terms of the FHA loan legally, and then renting it back from them.
If you're going to argue with me at least do me the courtesy of not putting words in my mouth. I posed this question and got several considerate answers that actually posed viable solutions. You're over here arguing with me about WHY I WANT CASH IN A DOWNTURN. Because...business sense...that's why. For crying out loud.
PS....a freeze on a HELOC is effectively a reduction. You can't draw against the full LOC. Call it whatever you want. Check out the response from Dereck Dombeck on this thread if you're still convinced that banks won't call your "loans". A line of credit is not a loan, so were are clear.
In some ways I think this is going towards the "if you have to ask.." direction. Let's face it, you are pulling together every "1 in a million" event and creating a rather extreme set of circumstances for yourself. As your profile shows 4 years of experience and two years or so on this forum, you have definitely been searching through the forum. I know equity stripping techniques have already been discussed in a much more formal context. Of course, probably best to just consult a qualified professional or two.
No need for the animosity. This is an open forum for discussion and bouncing ideas off of each other, but not an echo chamber. Everyone in this thread is providing feedback or concerns based on their own experience and research in an attempt to help, not get into an argument.
Whoa there brother. That is an exotic way of pulling out equity. Have another look at HELOCs. Here in California, it is no fee, no appraisal costs and only demand is hold the credit line for 3 years.
That is easiest and most cost effective way of pulling equity.
@Account Closed I was just looking at selling to myself too! For those of you that think it's the same as a refi... it's not when you consider the tax free capital gains from living in the property 2/5 years. Selling to yourself gives you a step-up in basis without paying tax. I understand you don't pay tax on HELOC funds or refi proceeds, but you would if you eventually sold it. What Whit is trying to do is avoid that.
This is not illegal. I don't know why that word is thrown around so much.
From talking with my accountants about it, however, the transaction does have to be arms length in order for your gains to remain tax free in the event of an audit.
We batted some other ideas back and forth.. What if I sold it to my buddy's LLC and and then he sold it back to my LLC (a different one) for the same price in a couple months? Not a bad idea.. You may get audited and the IRS may call a foul and hit you with a claim for the capital gains.
Either way it's a really good idea to take advantage of the tax free capital gain. So selling is probably the best bet, whether you sell to yourself or not. Just my $0.02. Good luck Whit