HELOC for downpayment

17 Replies

I’ve been trying to figure out a way to purchase more rental properties and grow my portfolio. I currently own two properties that cash flow nicely, plus my primary residence which I have ~$70k in equity.

I opened a HELOC on my primary home a while back and have gone back in forth in my own head on what to do with it. My initial plan was to use the HELOC funds as down-payments on a couple of additional rentals, and then use the cash flow to pay down the money taken from the HELOC. Over the course of a few years, the additional properties would essentially be free and my HELOC balance would be back to $0 so I could rinse and repeat.

That being said, I've heard several times to stay away from becoming over leveraged. While it seems to be a common suggestion, what exactly does that mean? If the additional properties I purchase using the HELOC cash flow and bring in positive income, what risk is there by being "over leveraged"?

I’m looking for input or advice on how to proceed given my current situation.

Thanks in advance!

@Spencer Harvey If I was in your shoes, I'd totally use the HELOC money for the BRRRR strategy instead of using it for down payment for a couple Buy & Holds . By doing that , you'll be able to pay off the HELOC within a year or so (when you refinance) which means you can repeat the entire process a lot sooner.

Regarding your specific concern, I wouldn't consider your situation as over leveraged. That 70K is literally gaining 0% right now. I'll just make sure that the return I'm getting from what I invest the HELOC in is way higher than the interest I'm paying on the HELOC.

@Spencer Harvey

You won't be over leveraged in the rental properties as you are using the HELOC on your primary home to purchase the properties, and I think it is a great way to go about getting more rental properties. You will still have the down payment of 15-25% in the rental properties so you have some equity in them still. And like you said, your intentions are to start paying back your HELOC right away.

I don't think getting a 100% LTV lien against the rental itself is a great idea, because when it comes time to sell, and the market drops in value you could be out that difference, and may not have the finances to close on the property.

Let me know if you have questions on financing.  

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Spencer, 

How long will it take to pay off the HELOC? I'd be surprised if it was less than 10 years, if you are only relying on net cashflow, after setting aside allowances for vacancy, repairs, lease-up fees, Capex, and emergencies.

Stress-test your payback at different interest rates. 

@Spencer Harvey A HELOC is an excellent tool! We have many investors that purchase our TK rental homes via a HELOC. You obviously have to ensure the cash flow is adequate to cover the payment for all loans on a property, but as you stated, once you pay the HELOC back you still have a cash flowing property that has likely appreciated, paid the loan down, received cash flow income & saved some in tax benefits. Because of all of that it absolutely makes sense to use the HELOC to expand your portfolio. Don't forget, there is such thing as return on equity, but if you're not using it, your return is 0. Best of luck! A HELOC is just another creative way to purchase more rental properties! Let me know if you have any specific questions for me.

I appreciate all the replies  

@Ley Nezifort I tried to find a property for quite a while that would work with the BRRRR strategy but even if I were to use the entire line, there aren't any properties around here for that price, at least not anywhere I'd want to invest. I entertained the idea of obtaining a conventional mortgage for the acquisition, rehabbing it, and then refi. The double set of closing costs would be a pretty big blow and probably put me in the same spot as if I used it for a downpayment instead.

Same with hard money, with 10% & points plus the 6.25% on the HELOC, I'm not sure I could make that work unless I'm missing something.

@Kevin Grove

@Kevin Grove a rough estimate I came up with was 6-8 years, depending on the purchase price, unless I put some of my own money towards it. Definitely something to think about though. I’d hate to get stuck holding the bag if my line went up to its max 21%. That was my main concern. A lot can happen in 6 years.

@Spencer Harvey

If you are planning on using the money long term, I'd suggest a home equity loan or cash out refinancing your existing mortgage (depending on your current interest rate). You'll be able to tap that equity cheaper than through a HELOC, it's also safer as you won't be subject to calls or stops on the line of credit. I threw together a way you can stress test your portfolio based on % of income reduction.

https://www.biggerpockets.com/...

I'm at this same spot in investing @Spencer Harvey. I currently have a HELOC with about $55k available, sitting at 4.75% (Sept 2019). I have 3 properties I'm considering and with my first pass the numbers look good (cash flow and overall value with under $10,000 in rehab costs). I have a preapproval for a conventional loan from a local bank for almost double the cost of the houses I'm looking at but @Jerry Padilla looks like we should talk. Financing options are an area I am admittedly lacking in knowledge. 

I made hundreds of HELOCs over the years to real estate investors, so I understand what you are going through. Federal Regulators hate seeing "real estate investment" on the "reason for loan" line of an application. They tend to have a higher default rate to...you guessed it...overleverage. That simply means that the amount someone is borrowing is quite high vs their cash flow. As investors start layering loan upon loan, they sometimes get into trouble when they hit a bump in the road and the house of cards starts to come down. That being said, if you don't lean out too far over your skis you should be OK with it. Interest rates are relatively low right now, so just be prepared to lock in the rate so, as rates go up, you don't have an issue paying the loan back. Good luck. 

@Spencer Harvey Using a HELOC as a down payment is a great day dreaming exercise, but I would highly recommend staying away from this strategy. What you're suggesting is buying a rental property with 100% leverage. You don't know you're over leveraged until you are.

Too many people on BP have been killing it the past few years.  All of their decisions have been winners, but way too many people haven't been punched in the mouth yet.  Their "decisions" look great because they're working out now, but what happens when they're given some tough luck.

Listen to people talk about 2006-2007. This is exactly what they were saying was going on. Investors thought the market was only going to go up or that their strategy was indefensible, until it wasn't. They used HELOC's, bought properties full value, refinanced multiple times, etc. And when the recession hit, people lost EVERYTHING. Why? Because being over-leveraged creates a house of cards. And one event, yes one simple event can cause all of the cards to tumble.

Here's the risk you're playing: you aren't aware of what can go wrong in your investing career.  And you also don't know the extent of it.  When you are 100% leveraged on a property, you are praying that nothing goes wrong and everything goes according to plan.  When you aren't so leveraged and have reserves, you can handle the moments when life really throws you some curve balls.

This doesn't mean that your strategy isn't sound. All I'm saying is that you're opening yourself up to a world of risk you aren't even aware exists. The only way I'd recommend anyone considering using a HELOC for buy-and-hold rental properties is that they have no interest in finding deals, they have a boat load of cash for reserves, and are experienced enough to know how to handle risk.

I'm in the process of buying a rental property using my HELOC on my primary residence as the down payment. I'm planning on aggressively paying down the HELOC, both cash flow from the property and normal paychecks to be able to repeat this process over and over.

I am considering using a HELOC to fund part of a new deal right now as well. I'm completing a BRRR and hoping to get some cash from that, then use some cash out of pocket and fund the balance using a HELOC so I don't have to deplete cash reserves. My intention is to use some of the cashflow and a bit of personal cash in the next 12 months to pay off the HELOC. The cashflow would pay off the HELOC amount borrowed in two years as the rents stand today. It is an 8 unit deal and 6 of the units have low rents that can be raised as well.

I think it is worth doing it, but the numbers need to work and you have to be in position with a backup plan and exit strategy to reduce your risk.

I've been considering a HELOC to try out the Brrrr method but I'm totally lost on doing all the calculations so it's going to take me some time to get a better understanding of it.

Morning everyone. I'm considering getting a HELOC on our primary residence here in Northern VA to use as a quick funding source should an opportunity present itself in areas where I'm searching for rental properties (Lynchburg and Norfolk, VA areas). My question to those of you who have used HELOCs is when do you actually have to make payments, and at what rate? I see there is a draw period and a payment period, generally ranging in years from 10-20, but I'm curious what payments you are required to make during those periods. My understanding is that regardless if you are in the draw or payment period, if you utilize the HELOC, you start making payments with whatever current interest rate you were given (currently seems to be a variable between 5-5.5% and subject to US prime rate). If you aren't using the funds, you may be subject to a monthly or yearly inactivity fee during the draw period.

Additionally, if you sell your primary home while you still have a HELOC in place, do lenders typically allow you to pay the HELOC at closing, or do they require that to be settled ahead of time (possibly impacting your ability to sell if you don't have the cash to pay off the HELOC amount)?

Thanks,

James  

I live in Lynchburg since 1993 when it mostly farmland, now it is booming thanks to Liberty university that just completed $500,000,000.00 worth of housing to house students from all over the world. We still have a shortage of apartments to housing more students that are moving in.
Some parents will buy 3 or 4 bedrooms homes to put their son or daughter and rent the rest, so the cost of living for their son/daughter is free.
Lynchburg is a great place to live, invest and raise a family.
Will be selling my house with the additional two vacant lots next Dec for Retirement and downsize; but will still be living Lynchburg, VA.
We have Liberty University, Lynchburg University; Central VA Community College "CVCC"; and the Biggest Hospital with 200 miles "Cental Virginia General Hospital", all within 15 minutes' drive from each other.  
Good luck with your move.

@Spencer Cornelia first off, great name!

You mentioned a lot of valid points. The part I don't get is about a recession. Hypothetically, let's say I was 100% leveraged with a property using the HELOC for downpayment and then conventional loan on the rest. I have it rented for XXXX, making a few hundred a month in cash flow after expenses in a B neighborhood. Other than the rates on the HELOC going up, what other risk am I looking at? The conventional loan payments will stay the same, rent will likely stay the same or drop slightly, and property values may go down temporarily. Even if that's the case and I plan to hold it long term, what would be my biggest risk?

On the other hand, it sounds like you have quite a bit of experience. Do you have any recommendations on a different strategy to plan I should to take to build my portfolio given my financial situation mentioned above?

@Spencer Harvey HELOC's should only be used on properties where you are rehabbing so that you can get your money back in a short time frame via the sell or refinance.

Your strategy likely won't even work because I can't imagine a bank lending to someone using a HELOC as the down payment. Your strategy is to be 100% leveraged on an investment property after properties have surged in value for 10 years.

What will go wrong? I don't know. And that's the problem. You don't know either. What happens if lending constricts and they call your HELOC due? It's happened before. If it happens again, you will have to fire sale everything or face foreclosure. That's just one semi-unlikely path. But there are others. And all it takes is one unfortunate event and you could lose everything

My point is that using borrowed funds to then be 100% leveraged on a property is playing with fire. I've heard many stories about people using this strategy in 2006. Keep refinancing and taking out HELOC's to buy investment properties because what could go wrong? They found out the hard way.