Using a HELOC for Down Payment w/ No Cash Flow?

22 Replies

Hey BP! I am a very new investor. I just closed on one investment property and have my eyes set on a second one. I have a question about using a HELOC to make it possible to work on this second deal.

I am thinking about using a HELOC for a down payment. The 4-plex I am looking at has a 12% cash on cash return per the BP Rental Property Calculator (this includes 5% set aside for vacancy and 10% set aside for maintenance/CapX). After all expenses, so long as all 4 units are rented, I would cash flow just enough to cover the P&I of my HELOC. So basically, I would put none of my own money down for this investment, but would be using virtually all my cash flow to pay my HELOC back each month over 20 year period.

The only way I can afford to do this second deal is to utilize this HELOC for a down payment. I am looking for any advice on if this strategy is wise or not. I know there are always variables to consider in addition to the information here. I appreciate any/all feedback and am open to additional questions as needed.

Thanks! 

I should also mention that my plan is to buy and hold as a long-term investment. I have no intention of flipping this property. 

If you believe the plan you just described is a good idea, then great.  By the way.  I have a property you might be interested in.  I can explain the terms to you if you're interested, but suffice to say that the bottom line is you would can tie up this property for the next 20 years...as long as you finance it.  With financing, the cash flow would be "zero", so you would be breaking even (as long as you didn't have any vacancies), but you would own the property.

Now, I know your new tenants will love the fact you will be paying them to live in "your" property, so you shouldn't have to worry about them damaging anything.

Like I said, I think this property is right up your alley...since it too allows you to be financially responsible for it, and not have to be concerned about actually making money.

If you are cash flowing just enough to cover your HELOC then you aren't actually getting any cash flow. I wouldn't do a deal that doesn't cash flow. Don't fall in love with the property, fall in love with the deal.

@Ernie Sturzinger If you just closed on your first property, what's the hurry on getting your second property? Why would you essentially be giving up your cash flow to get another property so quickly? I've seen a lot of new investors more concerned with getting a high number of doors in their portfolio than really making money. Since most of the responses have already said they wouldn't do this strategy I won't comment on that, I'll just say the Guru's constantly preaching get as many Doors in your portfolio as you can aren't discussing the fundamentals, that's clear by so many new investors posting about getting deals that are cash flowing little to no cash flow, but hey they added 4 or 8 doors. Those deals are one new roof or one new HVAC away from never making a profit. I would recommend building a solid REI portfolio where you're not going to worry about money or emergency exit strategies.

@Ernie Sturzinger congrats on beginning your REI journey. I'm definitely a fan of leverage as a way to grow your RE business, but I admit this raises a few red flags for me.

First is how dangerously thin your 2nd property cash flows are.  There's no room for uncontrollable variables like market shifts or economic cycles.  If there's an economic downturn in your market and rents are pressured and vacancies increase, you risk defaulting on your loan or at least having to come up with personal funds or cannibalize your set-asides to cover the shortfall.

Second, if your HELOC is on your first investment property, and if it's a 95% LTV, then this also puts your first property at risk too. For me, a HELOC is best for short-term capital needs and should be repaid as soon as possible. With no extra cash flow to pay-down the HELOC, it just feels like you're stretched too thin.

Another consideration is that your your debt service coverage ratio (DSCR) on that second property would be close to 1, which would make it difficult to obtain bank approval for it anyway.

My recommendation would be to either partner up or let your first property accumulate cash flow and stock-pile your W-2 savings before embarking on a second property.  Best of luck in whichever direction you decide to go!

@Ernie Sturzinger , on the surface it may look like Joe was trying to encourage you to go ahead and do this deal, but I reckon in a roundabout way, he was trying to talk you OUT of it! (Just in case you missed that).

ie. This deal could be seen as a good deal for the SELLER, not for an Investor!

My question: how did you calculate a 12% cash on cash return, if you're not putting ANY cash deposit down?

Is the HELOC for 20% down, or 25%? (Making a basic mistake at this stage can throw ALL your figures out!)

The reason why I reckon this'd be paying too much is: it's also being marketed to owner-occupiers!

I'll leave further comments until I see your response. Cheers...

Originally posted by @Brent Coombs :

@Ernie Sturzinger , on the surface it may look like Joe was trying to encourage you to go ahead and do this deal, but I reckon in a roundabout way, he was trying to talk you OUT of it! (Just in case you missed that).

ie. This deal could be seen as a good deal for the SELLER, not for an Investor!

My question: how did you calculate a 12% cash on cash return, if you're not putting ANY cash deposit down?

Is the HELOC for 20% down, or 25%? (Making a basic mistake at this stage can throw ALL your figures out!)

The reason why I reckon this'd be paying too much is: it's also being marketed to owner-occupiers!

I'll leave further comments until I see your response. Cheers...

 Bingo!!!!

That's why I wanted to sell him one of my properties, getting him the same end result as he was giving to his seller.

@Eric M. Thanks for the direct feedback. As someone new to this process, I am trying to be aware that I can get emotionally invested with a certain property and need to be more objective. Like you said, '...fall in love with the deal."

@Ray Johnson Ray, While looking for my first deal, this other deal came up as well and so I have been watching it for several months now. As I have closed my first property, I am still interested in this other deal. I have learned so much through this first deal, good and bad, and although it is soon after the close of my first deal, it is still interesting to me. So I wanted to get some feedback from more seasoned and experienced people than me. Thanks for the feedback. Appreciate your time.

@Chris Jensen @Brent Coombs

Hey guys,

I really appreciate your insight and feedback. A few bits of information to address your comments. 

The first property I closed on recently is a triplex and is cash flowing approximately $300/month. This includes putting 5% aside for vacancy and 10% for maintenance as well. I used my own cash for down payment on this property, so no HELOC.

The second property I am looking at is a 4-plex and on the market for $180,000. I would need to put 25% down, which is $45,000. I used my cash for down payment on first property, so am considering using HELOC for this second property.

After all expenses, including 10% put aside for vacancy, 10% put aside for maintenance, and 8% property management fee, this property would cash flow approximately $490/month. However, to take $50,000 out of HELOC, the monthly payment back to the bank for the HELOC would be approximately $390/month for 20 years.

Therefore, I could be cash flowing $100/month on a fully-rented 4-plex without using any of my own cash and leveraging the HELOC to make it possible to invest in a second property. As my primary strategy is buy and hold for long-term investment, this is why this concept intrigued me.

I'm not technically putting in any of my personal cash for this property, but getting a little benefit now, but looking to use this as passive income when it comes time to retirement,etc. However, if it is not rented fully for a while, I would likely need to put some of my own money into it. 

With this additional information, does this still seem too risky? How much would you recommend I build up in my reserves for vacancy and maintenance/CapEx funds? $5000 each?

Also, I did pick up that Joe V. was not recommending this deal. However, it seemed like it was answering in a very passive-aggressive way and very 'roundabout' way like you mentioned. This seemed weird to me as all I was looking for was some honest and straightforward feedback, like anyone else that uses these forums. So, thank you for the comment. I didn't answer him back, as I prefer to discuss these items in a straight forward manner as everyone else here has done a great job of doing.

Thanks in advance for your response. As I am learning how to work through this analysis, this feedback is very valuable to me. Appreciate your time and efforts. 

-Ernie

@Brent Coombs @Chris Jensen

Additionally, the 12% cash on cash return was before the HELOC was added into the mix. So, with HELOC at $390/month expense, it would come out to 2.25% cash on cash return at about $100/month cash flow.

Please let me know your thoughts. I appreciate the honest, straight forward feedback. No other way to learn. Thanks in advance!

It's a bad deal no matter how you look at it. It is irrelevant where the DP coms from if a property does not have positive cash flow all you have is speculation on appreciation.

You are working for nothing since every income property has tenants paying down the e mortgage and appreciation happens, or doesn't, anyway.

All income properties must produce positive cash flow based on a assumed 100% financing otherwise they will never produce positive cash flow (equity kills cash flow). This property is a terrible investment choice. 

Originally posted by @Ernie Sturzinger :

@Ray Johnson Ray, While looking for my first deal, this other deal came up as well and so I have been watching it for several months now. As I have closed my first property, I am still interested in this other deal. I have learned so much through this first deal, good and bad, and although it is soon after the close of my first deal, it is still interesting to me. So I wanted to get some feedback from more seasoned and experienced people than me. Thanks for the feedback. Appreciate your time.

 In my area good multyfalimy deals are being snached off after a couple of days of being on the market. How come you've been watching that deal for several months? Maybe it's over priced. Try to lower your potentioal offer and recalculate the numbers, maybe it will workout with lower price. 

Consider finding a deal that has cash flow now so that you are not waiting 20 years for it! On the surface, it may seam that you are gaining an asset for free, but you need to consider risk and the opportunity cost of missing out on an asset that can help increase your net worth and cash flow now. Since you are looking at 20 year time frame, consider the value of just $100/mo cash flow over 20 years. That generates $24k... probably enough to put a down payment on another property. Now multiply by 3-5 to see the value of $300-500/ cash flow on just one property. Now consider multiple properties. Run some numbers and you start to understand the time value of current year cash flow. You’ll see that delaying just ONE year has a significant impact on future cash flow. Consider the impact of tying up your cash for 20 years! This property may cost you significantly more than it could earn you.

Originally posted by @Ernie Sturzinger :

@Chris Jensen @Brent Coombs

Hey guys,

I really appreciate your insight and feedback. A few bits of information to address your comments. 

The first property I closed on recently is a triplex and is cash flowing approximately $300/month. This includes putting 5% aside for vacancy and 10% for maintenance as well. I used my own cash for down payment on this property, so no HELOC.

The second property I am looking at is a 4-plex and on the market for $180,000. I would need to put 25% down, which is $45,000. I used my cash for down payment on first property, so am considering using HELOC for this second property.

After all expenses, including 10% put aside for vacancy, 10% put aside for maintenance, and 8% property management fee, this property would cash flow approximately $490/month. However, to take $50,000 out of HELOC, the monthly payment back to the bank for the HELOC would be approximately $390/month for 20 years.

Therefore, I could be cash flowing $100/month on a fully-rented 4-plex without using any of my own cash and leveraging the HELOC to make it possible to invest in a second property. As my primary strategy is buy and hold for long-term investment, this is why this concept intrigued me.

I'm not technically putting in any of my personal cash for this property, but getting a little benefit now, but looking to use this as passive income when it comes time to retirement,etc. However, if it is not rented fully for a while, I would likely need to put some of my own money into it. 

With this additional information, does this still seem too risky? How much would you recommend I build up in my reserves for vacancy and maintenance/CapEx funds? $5000 each?

Also, I did pick up that Joe V. was not recommending this deal. However, it seemed like it was answering in a very passive-aggressive way and very 'roundabout' way like you mentioned. This seemed weird to me as all I was looking for was some honest and straightforward feedback, like anyone else that uses these forums. So, thank you for the comment. I didn't answer him back, as I prefer to discuss these items in a straight forward manner as everyone else here has done a great job of doing.

Thanks in advance for your response. As I am learning how to work through this analysis, this feedback is very valuable to me. Appreciate your time and efforts. 

-Ernie

 Agreed Joe’s response was weird

Originally posted by @Thomas S. :

It's a bad deal no matter how you look at it. It is irrelevant where the DP coms from if a property does not have positive cash flow all you have is speculation on appreciation.

You are working for nothing since every income property has tenants paying down the e mortgage and appreciation happens, or doesn't, anyway.

All income properties must produce positive cash flow based on a assumed 100% financing otherwise they will never produce positive cash flow (equity kills cash flow). This property is a terrible investment choice. 

how much  cash flow per month should you have based on 100% financing? 

@Alex Abanto , I have no difficulty recommending neutral cash flow (but not negative) deals IF: they'll appraise at 140%+ what you have into it when it comes time to refinance normally.

That way, you'd get your HELOC back, ready to go again! (BRRRR strategy).

The question is: will this one REALLY be at least cash neutral on average, going forward?

ie. At any given time, you'd have zero dollars left in any deal, but are accumulating 25%+ equity in every property?

And the Tenants are paying all your loans, with no further cost to you on average? [THAT's infinite returns!]

But, have you mentioned how much EQUITY you'd be buying on day one? ie. How much of a BARGAIN is it?

The point is: if you're NOT buying super-bargains - every time - how will you get your NEXT one, after this one?

@Ernie Sturzinger which home is the HELOC on, and what LTV is it? For example, is it a 80% HELOC on your main home, or a 95% HELOC on your 1st rental? Reason that's important to know is it lets you know how leveraged you'll be. With a HELOC on one of your properties that's tied up for 20 years on this new property, you're stretched really thin. A combined $400/month cash flow ($300 on property 1 and $100 on property 2) doesn't leave you a lot of wiggle room in case something big happens. There's a general rule that you should shoot for at least $100 cash flow per door per month, after all expenses and debt service. For you, that would be at least $700. Your first property gets there, but not this second one. So there's the concern for being stretched too thin. As an aside, cash on cash should be calc'ed after including debt service. There's just no way to make a return in the 2% range look attractive.

And like @Brent Coombs said, there's also the practical problem that all your funds are tied up in your current properties, and you have nothing left to acquire additional properties.  Unless you have excellent W-2 income that quickly generates "investable" funds, or you're willing to wait 10 years for your monthly cash flows to build up enough (assuming you don't need to cannibalize them in the meantime).

I would recommend using the BRRRR approach on a fixer-upper so you can get your funds back out of the property in 6-12 months and move on to the next deal. Using a HELOC to facilitate BRRRR would be an excellent approach. Still need to focus on higher cash flows and more attractive cash on cash returns either way.

Hope that helps.

@Chris Jensen could you help explain how you would use a HELOC to facilitate BRRRR? I can't seem to figure out how this would work....since you won't own the property outright how would you do a cash out refi?

@Account Closed , it's easy to do a cash-out refi on a home you don't own outright, assuming you have more equity in it than the minimum downpayment required on the newly appraised value of the property.  We're doing that right now on one of our single family homes.  You sign an application, agree to terms, lock in a rate, and go through the normal appraisal and title work.  At closing, the bank deducts the downpayment on the new loan, closing costs (including escrow amounts), and the balance of your previous mortgage from the refi proceeds, and the rest is a check to you.

Here's a quick example using the BRRRR method. Let's say you sign a contract on a home for $100k and pay $20k cash from your HELOC as the downpayment. The loan amount would be $80k. Then let's say you put $40k of rehab into the home, again using HELOC funds. Keep in mind that as soon as you use those HELOC funds you begin paying interest. Your total investment in the property is now $60k ($20k down and $40k rehab). Let's assume that the after repair value (ARV) of the property is $200k, and you rent the apartment out for a "seasoning period" of say 6-12 months.

After the seasoning period, you ask the bank to do a cash-out refinance, and you go through the process I described above. Sometimes banks will require a bit more downpayment on a cash-out refi, but for simplicity let's use 20% of the AMV or $40k, with closing costs of 2% or $4k. At closing, the bank will initiate a new loan for $160k (200k-40k) and deduct from the $160k proceeds: 1) $4k closing costs (including escrow items) and 2) $80k balance from original loan (will be lower since you'll have paid off some principal by now, but using $80k for simplicity). You'll get a check for $76k (160k-4k-80k). With that check you pay off your $60k HELOC balance, and you're left with a nice little $16k profit on the transaction. $16k profit on $60k total invested (using just your HELOC) = 26.7% pre-tax return, and you now have a nice, updated, rented property that you can put on autopilot while you put all that cash to work on the next BRRRR property.

Originally posted by @Chris Jensen :

@Account Closed , it's easy to do a cash-out refi on a home you don't own outright, assuming you have more equity in it than the minimum downpayment required on the newly appraised value of the property.  We're doing that right now on one of our single family homes.  You sign an application, agree to terms, lock in a rate, and go through the normal appraisal and title work.  At closing, the bank deducts the downpayment on the new loan, closing costs (including escrow amounts), and the balance of your previous mortgage from the refi proceeds, and the rest is a check to you.

Here's a quick example using the BRRRR method. Let's say you sign a contract on a home for $100k and pay $20k cash from your HELOC as the downpayment. The loan amount would be $80k. Then let's say you put $40k of rehab into the home, again using HELOC funds. Keep in mind that as soon as you use those HELOC funds you begin paying interest. Your total investment in the property is now $60k ($20k down and $40k rehab). Let's assume that the after repair value (ARV) of the property is $200k, and you rent the apartment out for a "seasoning period" of say 6-12 months.

After the seasoning period, you ask the bank to do a cash-out refinance, and you go through the process I described above. Sometimes banks will require a bit more downpayment on a cash-out refi, but for simplicity let's use 20% of the AMV or $40k, with closing costs of 2% or $4k. At closing, the bank will initiate a new loan for $160k (200k-40k) and deduct from the $160k proceeds: 1) $4k closing costs (including escrow items) and 2) $80k balance from original loan (will be lower since you'll have paid off some principal by now, but using $80k for simplicity). You'll get a check for $76k (160k-4k-80k). With that check you pay off your $60k HELOC balance, and you're left with a nice little $16k profit on the transaction. $16k profit on $60k total invested (using just your HELOC) = 26.7% pre-tax return, and you now have a nice, updated, rented property that you can put on autopilot while you put all that cash to work on the next BRRRR property.

how would this work if you have no ARV costs..say purchase price is 100k..and you use heloc for DP of $20k...you get traditional loan for $80k...you season the property for six to eight months and then ask for cash out refinance? cab you break ut down little further

Originally posted by @Alex Abanto :
Originally posted by @Chris Jensen:

@Account Closed , it's easy to do a cash-out refi on a home you don't own outright, assuming you have more equity in it than the minimum downpayment required on the newly appraised value of the property.  We're doing that right now on one of our single family homes.  You sign an application, agree to terms, lock in a rate, and go through the normal appraisal and title work.  At closing, the bank deducts the downpayment on the new loan, closing costs (including escrow amounts), and the balance of your previous mortgage from the refi proceeds, and the rest is a check to you.

Here's a quick example using the BRRRR method. Let's say you sign a contract on a home for $100k and pay $20k cash from your HELOC as the downpayment. The loan amount would be $80k. Then let's say you put $40k of rehab into the home, again using HELOC funds. Keep in mind that as soon as you use those HELOC funds you begin paying interest. Your total investment in the property is now $60k ($20k down and $40k rehab). Let's assume that the after repair value (ARV) of the property is $200k, and you rent the apartment out for a "seasoning period" of say 6-12 months.

After the seasoning period, you ask the bank to do a cash-out refinance, and you go through the process I described above. Sometimes banks will require a bit more downpayment on a cash-out refi, but for simplicity let's use 20% of the AMV or $40k, with closing costs of 2% or $4k. At closing, the bank will initiate a new loan for $160k (200k-40k) and deduct from the $160k proceeds: 1) $4k closing costs (including escrow items) and 2) $80k balance from original loan (will be lower since you'll have paid off some principal by now, but using $80k for simplicity). You'll get a check for $76k (160k-4k-80k). With that check you pay off your $60k HELOC balance, and you're left with a nice little $16k profit on the transaction. $16k profit on $60k total invested (using just your HELOC) = 26.7% pre-tax return, and you now have a nice, updated, rented property that you can put on autopilot while you put all that cash to work on the next BRRRR property.

how would this work if you have no ARV costs..say purchase price is 100k..and you use heloc for DP of $20k...you get traditional loan for $80k...you season the property for six to eight months and then ask for cash out refinance? cab you break ut down little further

Then you'd want/need that $100k home to be already worth $130k! Why? Because, it won't work if you're not buying (or value-adding) extra equity than you're paying for!

Same principle as what pawn brokers do: pay bargain prices only! Real bargains!

Yes, more easily said than done - but, it is what it is! Cheers...

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