HELOC vs Cash-out Refi for Rental Property?

Question

Hello all, I'm looking to pick up a rental property and am weighing the options between using a HELOC or a cash-out refinance of my primary residence and looking for experienced opinions.

I just did a cash-out refi in April and locked in a 3% rate but still have ~$200k in equity. I'm now looking to pick up a rental property for about $80k and would prefer not to cash out investments or use savings to make a down payment. Current HELOC rates for my lender are "Prime -.25%", which is currently 3%, and is variable. The obvious benefits are that it's faster than a refi and is only a fraction of the closing cost. And the downside, of course, is that the rate is variable.

If I were to do another cash-out refi, I could lock in a 2.75% rate for 30 years, but would be subject to ~$5,200 in closing costs and would take longer to process.

What would you do?

Jack Chase · Answer

@Jaysen Medhurst thanks for clarifying that - I figured that was the case but hadn't looked much into it. Makes sense.

@Darius Ogloza great idea, I will run those numbers. I highly doubt the higher interest rate of the HELOC will cost an extra $5k in a few years, but I do worry about its expense in the long term and whether I should just bite the bullet on closing costs now.

Darius Ogloza · Answer

High closing costs are a deadweight loss in this situation. The HELOC is far more flexible. I would do the math using a hypothetical 5% prime (4.75%) and test that against the total cost of the cash-out refi over a 3-4 year period. This is your likely worst case given the series of catastrophes we have encountered in 2020.

Jaysen Medhurst · Answer

Are you suggesting the use of a HELOC to purchase cash and then refi, @Jack Chase? That's certainly a popular strategy. One thing to keep in mind is that at refi the lender will likely want you to have 20-25% equity in the property. That means you either can't pay back all of the HELOC at refi or you must add value in someway, making the deal a BRRRR.

Jack Chase · Answer

@Jaysen Medhurst - thank you for the helpful response. The HELOC is very tempting, although ideally I would hold on to this property long-term as a vacation rental. I suppose I could use the HELOC for fast(er) cash and then once I own the property I could refinance to obtain a traditional 30 year mortgage?

Jaysen Medhurst · Answer

@Jack Chase, this question comes up all the time in the forums. Generally, I recommend a HELOC. Obviously, the fees are much, much lower. The real advantage over time is that you only pay interest on the money you're using, when you use it. The one caveat is that HELOCs are best suited for short-term financing. Perfect for flips or BRRRRs.

HELOC vs Cash-out Refi for Rental Property?

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