Using primary residence HELOC to lend money?
Vancouver · Member since 2013 · 159 posts · 6 votes
Hi,
I was wondering if it was a good idea to lend money from a HELOC on your primary residence?
My thinking is if I own my primary residence free and clear, I take out a HELOC and use it to invest in lending opportunities when the difference in interest makes it worth it...
Ex: HELOC @ 6% vs. Private Loan @ 12%.
In theory, at least to me, this makes sense. I have tried looking for past threads about this and didn't find much on the lending side of it. Is there any downfall to this strategy?
I could refinance, but I just prefer not to have mortgage payments on my primary residence. Thanks.
I was wondering if it was a good idea to lend money from a HELOC on your primary residence?
My thinking is if I own my primary residence free and clear, I take out a HELOC and use it to invest in lending opportunities when the difference in interest makes it worth it...
Ex: HELOC @ 6% vs. Private Loan @ 12%.
In theory, at least to me, this makes sense. I have tried looking for past threads about this and didn't find much on the lending side of it. Is there any downfall to this strategy?
I could refinance, but I just prefer not to have mortgage payments on my primary residence. Thanks.
It is a source of capital but not without risk.
If you are a lender on a loan that goes bad & you are unable to make the payments on your HELOC you could lose your house in foreclosure.
I am not sure I understand your statement "I prefer not to have mortgage payments on my primary residence". You would have monthly payments when you borrow from your HELOC but not when you aren't using it. The difference with a refi, is that you would be have monthly payments on the proceeds from whether you were using it or not. Another risk to a HELOC is banks usually reserve the right to close your line under certain conditions.
Also, you have to consider that HELOC is typically an adjustable rate that can move very quickly against you if you are not careful.
With a straight refi, you have the choice of locking in a longer fixed term. 15-30 years.
I have used a HELOC to purchase other homes, and am definitely in favor of using HELOCs as a leveraging strategy.
If you plan on tying up the money in a loan or a long term buy and hold, I would suggest a 30 year mortgage. Interest rates will be close to the same, today, but after your HELOC adjusts over time, you will probably save money in the long run as interest rates rise.
As far as using the money for a private loan, I personally do not have experience with that and don't want to comment.
Make money with money? That is a good idea.
Sounds brilliant to me!
I was wondering if it was a good idea to lend money from a HELOC on your primary residence?
My thinking is if I own my primary residence free and clear, I take out a HELOC and use it to invest in lending opportunities when the difference in interest makes it worth it...
Ex: HELOC @ 6% vs. Private Loan @ 12%.
In theory, at least to me, this makes sense. I have tried looking for past threads about this and didn't find much on the lending side of it. Is there any downfall to this strategy?
I could refinance, but I just prefer not to have mortgage payments on my primary residence. Thanks.
It is a source of capital but not without risk.
If you are a lender on a loan that goes bad & you are unable to make the payments on your HELOC you could lose your house in foreclosure.
I am not sure I understand your statement "I prefer not to have mortgage payments on my primary residence". You would have monthly payments when you borrow from your HELOC but not when you aren't using it. The difference with a refi, is that you would be have monthly payments on the proceeds from whether you were using it or not. Another risk to a HELOC is banks usually reserve the right to close your line under certain conditions.
Also, you have to consider that HELOC is typically an adjustable rate that can move very quickly against you if you are not careful.
With a straight refi, you have the choice of locking in a longer fixed term. 15-30 years.
I am a big believer in using OPM (other people's money) to invest. The HELOC idea is a good option, however, as Ellis pointed out, it does not come without risk. Fluctuating interest rates, risk of your borrower defaulting, equity in your home decreasing causing lender to reduce HELOC amount, etc are all risks associated with such a venture.
If you were to use the money to lend out, make sure you know what you are doing and that your LTV is at or below 65% to keep you in a safe equity position in the event of your borrower defaulting. You would also want to be sure that in the event of default, you have the means to cover the HELOC payment until the debt is cured via foreclosure or other means.
You should be able to get a HELOC for well under 6%. In fact, it should be 4% or below.helocs are typically set for 15 year loans and the benefit of this over a straight refi is your ability to pull and pay back at any time with ease, thus lower interest due and removing the costs of straight refi loans. They have no ability to payback then pull from again as HELOC loans do.
The only downfalls I can see are:
1) If you make a bad loan and lose money you are still on the hook for the HELOC. This is possible especially if you don't have a lot of lending experience.
2) Make sure you have money to make HELOC payments and foreclosure costs if borrower stops paying and you have to take property back, fix-up and resell.
3) If the HELOC requires a minimum draw and you aren't able to lend the money you will still have to pay the 6% without the 12% coming in.
4) Make sure that if there is a balloon on the HELOC you have the money to pay it off when it comes due. HELOC's that I've seen are fully amortizing after 10 yr ... no balloon.
good idea to use money to make money. just be sure to lend it out to a borrower with a proven track record.
Thanks everybody for all the responses.
The general consensus I have gotten is that it would make sense to do this... A couple of things that I would make sure to do would be:
1) Find a reputable loan broker with a long, proven track record.
2) Don't invest more than 65% of the total HELOC amount available. (Which might be hard to do if the lending produces good returns!)
3) Keep a reserve to make the HELOC payments in case the borrower doesn't pay and have to take over the borrower's property.
4) Learn more about HELOC's... (Balloon payments, interest only payments, etc..) I never even thought about the different types of them.
Does this sound like a relatively safe plan? So far the suggestions have been great, any other ideas?
Thanks again.
looks like you got it except for item 2. It should read, never lend more than 65% of the value of the property securing the loan.
Thanks @Will Barnard I did misunderstand what you said... I thought you originally meant to only use 65% of your available line of credit to lend out just to be extra safe. The loan broker I have used a couple of times usually only goes to 65% LTV. I'm still learning the whole process, like how to read all the 'due diligence' documents he sends over. I won't lend thru the HELOC until I understand a bit more about the process and develop a bit of a history with the broker.
Do you know what is a standard return most people are getting using a broker? I'm sure finding your own borrowers would generate better returns, but I'm not at the point where I'm comfortable doing that.
Thanks again.
The broker does not necessarily determine your return, though, if they hold the borrower, they hold a say in it. If you are using brokers to find lenders. then you are subject to their requests, of course you can say yes or no. As a lender, you should be shooting for a 10% minimum yield on your money. This way, if you are using OPM via a HELOC, your arbitrage (if the HELOC costs are at 4%) is the 6% difference.
Regardless if you find your own borrowers or not, you should involve a broker for the simple insurance of compliance and disclosure. You should also have YOUR attorney draft YOUR loan docs that protect YOU! This will have an initial cost of course, but part of the cost of doing business legitimately.
Brokers will typically charge either a flat fee for underwriting the loan or anywhere from a half point to 3 points. Look to pay no more than one point for such a service and that point should be paid for by the borrower. The lower the points to the borrower, the higher the interest they can afford to pay YOU. Look for Win-Win-Win situations where each of the 3 parties are benefited.
Another option is to get educated on note buying and then get a good number of brokers who can offer you notes to purchase. When purchasing performing notes at a discount, you can easily see double digit yields and pick and choose your safety zones. I prefer no more than 65% LTV, at least one, preferably 2 years pay history (seasoning), and that the original loan amount and value was based on real numbers and not in an inflated market. For example, any note generated in 2005-2006 which was a peak part of the RE market had inflated values and as such, the LTV could be grossly obscured. In contrast, a note started in 2009-2011 is perfect as the market was depressed down after the bubble burst and values were not artificially and manipulatively inflated, thus I am more comfortable with the valuation at the time.
Today's value of course takes precedence, so make sure you have the ability to evaluate true market value. Get a second or even a third opinion too from an agent or title company.
In my view, this is the best and easiest way to tap and monetize the equity in your home. A few more considerations:
You might be able to deduct your HELOC interest but you will have to pay tax on your entire interest income. In the end, the difference between 6% and 12% (your made up numbers, I know) after tax will not be as much as it looks. Obviously, you want to maximize the difference.
It’s easy to lower your rates but murder to raise them. Make sure you understand the prevailing rates in your area and don’t be afraid to charge them. Private money doesn’t have to imply someone who doesn’t understand the value of his money. There is no standard rate.
Currently, returns (points & interest) in the LA area are in the high teens. I don't know about Phoenix but suspect it's comparable. Similarly, shop hard for a HELOC and understand all your options. Some banks advertise great, below prime interest rates, but hide minimum rates and other terms in the fine print.
Ask around first, and then tell the bank how much you want to borrow. Don’t let them tell you. Make it substantially more then you think they’ll lend. This was a suggestion someone once gave me and I was surprised, actually shocked, that it worked for us.
All HELOC's that I'm aware of can be cancelled for any reason by the bank at their option. This doesn't mean you have to pay the loan back immediately. It means you can keep what you borrowed so long as you continue to make the payments. If you pay more, perhaps because a borrower re-paid you, you won't be able to borrow it back again.
Once you get your business running to where you're loaned out most of the time, consider withdrawing the entire HELOC amount so long as you know you can earn and make the payments. Sooner is better than later because you never know what the bank will do with no warning. (You might also consider a refi instead, if this is long term. Many pros & cons here.) We did this years ago, just before our bank cancelled our HELOC and we still have and loan the money. It's been awesome but you have to protect yourself.
Don't loan long term. Six month term, maximum, and certainly less than a year. This pretty much means you'll be loaning on flips. You can always choose to provide an extension to your borrower. If interest rates begin to rise, you'll want to make sure you can begin paying your HELOC back, cancelled or not, as your borrowers repay you.
Will's suggestion was to loan 65% of LTV, not 65% of your available HELOC. All lenders are different and all lending terms are regional. LTV could be the purchase price or the after repaired value (ARV). This is your call. Similarly, you can raise or lower the percent but understand that this is a competitive business and your local market will dictate your terms to a degree. How aggressive and competitive do you want to be?
There have been lots of threads here about how to get into the lending business, but none specifically that I'm aware of about using HELOC's. Good question, Taylor.
Jeff
Will, I've learned about FCI Exchange, what other note brokers might you think are worth investigating?
Thanks again for all the responses, I'm really learning a lot.
@Will Barnard I have been reading thru old threads trying to learn about buying notes. Just based on your input, it seems like something I'd be interested in. However, I have zero knowledge or experience about buying notes. Do you have any recommendations for books or any other sources of education on the topic?
@Jeff S I'm glad you view this as a good strategy. I have been trying to learn about the different types of HELOCs and have called a couple banks asking about the different options. I never realized there were so many different options. If returns are in the mid-high teens that sounds great, it would make this decision a no brainer for me! Since I'm new to this, I'm also not great with the tax implications so I'd ask my CPA about deducting the interest of the HELOC and other considerations. I will make sure I keep the loan term short, the previous loans I've made thru the broker have been short term, around 6 months before I got my money back.
Thank you guys again...
Recommendations:
1) Invest in Debt -Jimmy Napier
2) Smart Trust Deed Investment in California- George Coates (California Specific & Out of print but a great foundation)
3) Take a class & learn how to use a financial calculator HP10BII is my preference.
This is a good start.
@Jeff S I'm glad you view this as a good strategy. I have been trying to learn about the different types of HELOCs and have called a couple banks asking about the different options. I never realized there were so many different options. If returns are in the mid-high teens that sounds great, it would make this decision a no brainer for me! Since I'm new to this, I'm also not great with the tax implications so I'd ask my CPA about deducting the interest of the HELOC and other considerations. I will make sure I keep the loan term short, the previous loans I've made thru the broker have been short term, around 6 months before I got my money back.
Thank you guys again...
The interest will be deducted in relation to the property or notes that you buy. If you buy a rental it would be deducted on Schedule E. It you buy notes, your interested would be deducted on Form 4592 Investment Interest Deduction on Schedule A.
Taylor, Ellis gave you great advice, thanks Ellis.
@Ellis San Jose Thanks for recommendations. I just bought them off Amazon so I will get reading shortly!
From the lenders point of view, what if the note (or JV agreement) calls for a cut of the profits on the back end, in addition to the note interest, is that deducted same as interest or is it treated like earned income as it would be for the reahaber?
From the lenders point of view, what if the note (or JV agreement) calls for a cut of the profits on the back end, in addition to the note interest, is that deducted same as interest or is it treated like earned income as it would be for the reahaber?
David
This is why I recommend investing from an entity. It allows you to only add the net profit to your income. A cut of profit would be taxed as interest. So yes, the deduction for interest paid would be on Form 4592 and carry to schedule A subject to the 2% floor of agi.
There is one advantage though. If you have less than 100k out on your heloc you can deduct the interest with your regular mortgage interest.
David
This is why I recommend investing from an entity. It allows you to only add the net profit to your income. A cut of profit would be taxed as interest. So yes, the deduction for interest paid would be on Form 4592 and carry to schedule A subject to the 2% floor of agi.
There is one advantage though. If you have less than 100k out on your heloc you can deduct the interest with your regular mortgage interest.
Just so I'm clear on this. That was a pretty high density statement.
A lender's share of the profits, acquired pursuant to a JV agreement or promissory note, is taxed as interest. And this has nothing to do with deducting heloc interest.
A portion of the heloc interest (2% of agi) is not deductible, unless you have less than 100k out on the heloc. Or unless done through an entity.
If lending through an entity (s-corp for example) 1) the profit split is still taxed as interest and 2) all the heloc interest is deductable regardless of the 2% agi floor and regardless if you have more than 100k out on your heloc.
Is that accurate?
@Taylor GreenPerforming and non-performing notes, even second’s, can be great and return substantially more than rehab loans. They tend to be longer-term investments however and, in my view, are not suitable for use with a HELOC.
You do not want to deploy HELOC money into a relatively long-term illiquid investment that you cannot completely control. Many of us who are a bit older will remember how high interest rates were in the early 80's and the double-digit mortgage interest rates we paid then. Ouch. If/when rates start to go up, you'll want to be able to get out of (i.e. repay) your HELOC quickly and notes will not necessarily give you that option.
Because of the tax deferral or even avoidance, retirement plans thru a self-directed 401k or IRA are the perfect place for notes and I strongly encourage you to look at them. It's off-topic in this thread, but widely written about here.
In addition to the books Ellis mentioned above, which are excellent, you might consider taking Gary Johnston’s Money Not Math class reviewed here, as well as his Financial Freedom course. You’ll learn to use an HP financial calculator but that’s not the focus. Both courses are about acquiring and accumulating wealth and financial literacy. Money Not Math dwells more on evaluating cash flows and notes. Neither should be missed.
Jeff
I am so glad you brought up Gary Johnston's class. I wasn't sure if that was ok to recommend or if it would be deemed solicitation.
David
This is why I recommend investing from an entity. It allows you to only add the net profit to your income. A cut of profit would be taxed as interest. So yes, the deduction for interest paid would be on Form 4592 and carry to schedule A subject to the 2% floor of agi.
There is one advantage though. If you have less than 100k out on your heloc you can deduct the interest with your regular mortgage interest.
Just so I'm clear on this. That was a pretty high density statement.
A lender's share of the profits, acquired pursuant to a JV agreement or promissory note, is taxed as interest. And this has nothing to do with deducting heloc interest.
A portion of the heloc interest (2% of agi) is not deductible, unless you have less than 100k out on the heloc. Or unless done through an entity.
If lending through an entity (s-corp for example) 1) the profit split is still taxed as interest and 2) all the heloc interest is deductable regardless of the 2% agi floor and regardless if you have more than 100k out on your heloc.
Is that accurate?
David, so far correct, except the lending entity would treat it as ordinary income. The money you gave to the entity is contributed to funds or you could treat it as a loan to the entity and then itbwould be income minus the interest expense. Sorry if there are any spelling issues I'm typing from my phone.
Thanks for you response, I know you contribute a lot to this site.
So, if profit split comes through my entity it's ordinary income thus subject to SS, FICA tax where if it comes to me personally it is interest income thus not subject to those taxes? ... sounds bad.
Thanks for you response, I know you contribute a lot to this site.