When and when not to use a HELOC for cash-flowing investments?

Question

I'm considering using a HELOC to fund investments that cash flow right away. In the best case, it seems like a pretty obvious arbitrage between the rate of my HELOC and the rate of return on the investment. But, I'm new and I know better than to just jump in so I thought I would ask you folks to see what the collective wisdom I could get.

Under what conditions would you use a HELOC to fund an investment? When would you not?

Varinder Kumar · Answer

@Dave Van Horn

Well i would pay the heloc payments, but the NPN I bought is already foreclosed on, so by the time i get the collateral file which is about 30 days from purchase of note the asset should be already REO. I would just list it for sale as cash only, or sell it to another investor in that area. Obviously my numbers already done on it to if i were to sell to another investor so that they can flip the home i would still have a great profit and leave enough meat on the bone of course for them to profit after flipping it also. And if i were to list it with an agent i would probably get a little bit more for it but it would probably take a little bit longer to sell, maybe. With the proceeds of the sale i would pay off HELOC. Thats my strategy right now. I am not looking to get anything re-performing as of just yet.

Dave Van Horn · Answer

@Varinder Kumar

Hm, I guess I don't have too much to add on the subject. I've never used a HELOC to buy NPNs. I've only used HELOCs to buy rep and warranted re-performing notes and for private money deals. NPN's are more speculative so there's definitely more risk involved in that scenario than if you were to buy a Re-Performing note (especially one backed by a warranty).

I'm not clear on your process that guarantees the sale of your NPN in such a short amount of time, but if you have a buyer lined up (and a backup) I suppose you don't need much else as long as you're comfortable with the risks at hand.

If you plan to workout the loan and turn it re-performing, it's completely a different story. Our exits with the majority of NPNs are usually between  6 to 12 months, some times longer than that. So it goes back to the question of "how are you going to pay the HELOC back until it becomes re-performing?" And that's a balance and risk level that needs to be understood before venturing into such a deal.

Plus you may want  to consider the diversity of your investment. Clearly it depends on the type of assets but generally speaking,  there tends to be less risk in a pool of NPNs vs. a single NPN. Same goes for most investments; it's tough to recommend putting all your eggs in one basket.

Anyway, hope this info helps.

Best of luck,

Dave

Varinder Kumar · Answer

@Dave Van Horn I agree. I am looking to utilize a HELOC on my rental to fund a NPN which I would sell for profit. Of course the NPN would have to meet certain conditions so that i am able to sell it in a short period of time.  Id like to hear your thoughts on this concept of funding NPN's via HELOC Dave. Thanks!

Dave Van Horn · Answer

Hi Kelly Byrd,

I think with utilizing HELOCs it's not just about the arbitrage, it's also about the risk and the liquidity of the investment. If you're comfortable with/can manage the risk, than utilizing a HELOC is definitely worthwhile.

I prefer to use my HELOCs for short term and/or liquid investments - like institutional notes or hard money loans.

I personally only like to use hard or private money for investments like BRRR because of the risk involved with the money being tied up. Especially if it's a HELOC on my primary. I often tell the story  of my friend who almost lost his primary residence since he had a heart attack in the middle of renovations. This put him out of work for 9 months. Since he didn’t use hard money,  he couldn’t just hand the property back to the lender.  Instead, because  he wanted to save a couple of points, he almost lost his family’s home  because he nearly defaulted on the HELOC. Fortunately he had the help of  friends and family that kept him afloat.

If he had done it the other  way around, he would have only had to hand over the hard money lender  the keys and he could have lived off his HELOC while he was recovering. Or if he took the HELOC out and purchased a more liquid asset where he could have lived off the cashflow or quickly  liquidated, he would be a much more favorable scenario. So it was a lesson that I learned from his story that I hope helps others. I also realized not too long after using HELOCs that I can do twice as many deals if I put my HELOC to work on liquid/short term investments and BRRR with hard money.

Best,

Dave

Naveed Q. · Answer

Kelly Byrd I have been doing some reading on HELOC's and so far I have found that the rates are variable so in your example what happens if Y% changes ? since you are looking long term. So far it looks like mostly HELOC is used for fix and flips or buy cash, rehab, rent, refinance (BRRR) pull the cash out and start all over again. So the investment per cycle for using HELOC is short and not long term.

Darren Eady · Answer

Kelly Byrd

I've used my 1st position HELOC for many years for real estate investments.  Performing mortgage notes are probably the best fit for a passive return.

Kelly Byrd · Answer

I've thought about this and there are a few ways to mitigate this:

- My HELOC has a max cap on interest, so I know the worst it could get. Also, it can't rise more than 2% a year.

- Some HELOCs (mine does) allow you to have a fixed-rate draw or two. So I could get a known fixed rate.

Kelly Byrd · Answer

So I was thinking something  like doing a private money loan or a note fund that pays a given preferred rate monthly. It's a much simpler transaction there: "I get X% per month from investment, I pay Y% to the HELOC servicer" The only risk I see is losing my principal.

Joshua D. · Answer

I like using a HELOC when I know I can pay it back quickly with the investment.

We used it on a BRRRR earlier this year.  WE bought with the heloc and the refinanced and paid the loan off. I don't like having adjustable rate note as a long term plan, but that is just me.