Heloc on a property that is totally paid off

[Michael Sontheimer]

Hi. I have been investigating the best way to get the down payment for my second investment property. I paid cash for the first so it is totally paid off. I am interested in a HELOC but have only seen this done when there is still an existing loan/mortgage on the property. Is it possible/wise to get a HELOC for the property that I have free and clear?

I only have one deal under my belt but I am excited to move forward and appreciate any help you could give. Thanks in advance!

[Greg Scott]

Think through this mental model with me.   Say you have a $100K house that rents for $1000/mo, has $5K per year in expenses (taxes, insurance, repairs).   

  Owning Free and Clear

   - Cash flow is $1000*12months less $5K or $7K per year.   Your equity is $100K so return on equity is 7%.

  With a Mortgage

   - Take a 50% loan out on the first property and buy one exactly like it, two properties, $200K value, $100K in mortgages

   - Cash flow is $1000*12monts*2 properties less $10K or $14K (before interest)  If interest is at 5%, your cash flow is $9K

  - Since your equity is the same, your return on equity has gone from 7% to 9% and cash flow has gone up.

  Wait, it Gets Better

   - In this illustration, depreciation will be about $3K per year per house

   - With one house, your cash flow is $7K and taxable income will be $4K

   - With two houses, your cash flow is $9K but your taxable income drops to $3K

50% LTV is a very conservative position. If you are comfortable with it, the numbers above get better with higher leverage. (Buy 4 houses with 75% LTV.)

I would look at putting a mortgage on either of your properties.