Posted over 1 year ago

How to Use a HELOC to Purchase Investment Properties

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Let’s assume you saved up money for over a year, acquired a rental property, and now you’re back at zero savings in the bank. What do you do next? Well, hopefully, if you purchased the property under the appraised value and you put the standard 15 to 20 percent down, the property you purchased has some equity that you can tap into. We can take advantage of that equity by taking out a Home Equity Line of Credit or HELOC for short. In this article I will explain what a HELOC is and how you can use it to acquire more investment properties.

What is a HELOC and how does it work

A Home Equity Line of Credit is a loan that is backed by some qualifying collateral such as a primary home or investment property. Opening a HELOC account versus doing a cash-out refinance has several advantages: the closing costs are generally much less, you only pay interest on money that you withdraw from your account, you can borrow money and pay it back as you please, and you are not increasing the loan amount on your original mortgage or increasing the length of the loan.

Understanding equity

Equity is the difference between the value of the property and the balance remaining on the loan, also called the debt balance. Assume you purchased a property for $200,000 using a conventional mortgage with 20% down and the appraised value came back at $210,000. Therefore, you now have $50,000 of equity in that property.

Equity = $210,000 - ($200,000 x (1 - 0.20)) = $50,000

What can you do with equity

If you have enough equity in your primary home or investment property you can take out a HELOC against that equity. This money can be used for anything you wish. Because we are in the business of compounding our money, the HELOC would best be used for acquiring more investment properties. We can then use that money as a down payment for another mortgage— just make sure to disclose to the mortgage lender that some or all of the down payment money is borrowed.

To use the HELOC you can directly transfer cash into your bank account for purchases. You are also issued checks from the bank to make purchases directly from your HELOC account.

How much credit are you given

With a HELOC, a lender will lend a certain percentage of your property’s loan-to-value (LTV). Similar to the scenario above, suppose your property was appraised at $210,000 and now your current loan balance is $135,000. This means you have $75,000 in equity in that property. If your lender offers an 80% LTV, you will receive a HELOC for $33,000. Here's the math:

(Appraised Value x LTV) - Remaining Loan Balance = Potential HELOC Value

or

($210,000 x 0.80) - $135,000 = $33,000

How do interest and payments work for a HELOC

Lenders offer several variations of the terms of a HELOC, but a popular HELOC structure is an interest only loan where the interest rate fluctuates and typically is tied to the Prime rate. In our case, our lender offered us a non-owner occupied HELOC with an interest rate of Prime + 1.0%. As of February 6, 2020, the Prime rate was 4.75%.

This HELOC has a draw period and a repayment period. The draw period is when you can withdraw money from the HELOC while making interest only payments. This period is usually 10 to 15 years and if only minimum payments are made during the draw period, the loan balance will not decrease. Following the draw period is the repayment period of 20 years. This is when it is required to make both principal and interest payments on the loan in order to pay off the balance.

Getting a HELOC on an investment property

Many lenders offer HELOCs on primary residences and only a few will offer a HELOC on an investment property. Lenders are reluctant to issue a HELOC on an investment property because they generally view it as more risk. When searching for a lender try calling both regional and national credit unions to find out the types of HELOCs they offer. Usually credit unions will lend on an investment property at a slightly higher interest rate with less of an LTV than primary homes. Many lenders also require that the investment property that the loan will be taken out against has a lease in place.

How to use a HELOC to build your rental portfolio

Building a rental portfolio takes time and money, so real estate investors are always looking for ways to acquire more properties with very little money down. A popular strategy is to use a HELOC as the down payment to acquire more investment properties. Of course, it is important that you make sure you’re not over-leveraging yourself by going this route. If you use your HELOC for a down payment on a new investment property, I strongly suggest having a plan to pay the HELOC back as quickly as possible, preferably within twelve months. HELOCs usually have variable interest rates. If you were planning on paying back this loan over a five-year period there is a higher risk of rates increasing during that period compared to if you paid back the borrowed money within one year. This happened to a lot of home owners and investors during the 2008 housing crisis when the Prime rate increased from 4.00% in May 2004 to 8.25% in July 2008. Their monthly mortgage payments increased above what they could afford, which caused many people to fail making their mortgage payments and having their properties foreclosed on.

A real HELOC example

I’ll give you an example of how we used our HELOC to acquire our third rental property:

  • • One of our rental properties had $48,000 of equity in it due to us acquiring it at a great deal and doing some minor rehab work to increase the value of the property
  • • We were granted a HELOC of $24,400 with a variable interest rate of Prime + 1.0% with a 10-year draw period
  • • Purchased a rental property for $123,000 with a 30-year conventional loan and a 15% down payment ($18,450)
  • • Of the $18,450 down payment we used $15,000 from our HELOC
  • • Created a plan to pay back the $15,000 in one year by making monthly payments of $1,250

    Since our HELOC is interest-only payments for the first ten years, our first payment due was $69.93. The amount due each month decreased as we paid back more of the principal. But if we had only paid the amount due each month, which is only interest, we wouldn’t have paid down any of the principal and would be at risk due to the variable interest rate. I am happy to say that we are about to finish paying back the $15,000 of the HELOC this month in February 2020 as we originally planned.

    Getting a home equity line of credit on an investment property takes some work, but it is definitely possible once you find a lender willing to issue you the loan and you have adequate equity in the property you want to use as collateral. HELOCs provide several advantages such as the facts that you only pay interest on money that you withdraw from your account, and you’re not increasing the loan amount or length of your original mortgage. The money from the HELOC can be used for rehabs to add value or even down payments to purchase additional investment properties. If you have enough equity in your property, you can make an “all cash” offer on a new investment property and get an even better deal. Leave a comment if you have a HELOC on an investment property and would like to share your experience.

    Thanks for reading!



    Comments (17)

    1. Hi. Your article stated to have plans to pay back the HELOC quickly, but I didn't see any recommended strategies on how to do this. Perhaps I missed it, but I reread it and couldn't find any strategies on quickly paying off the HELOC. Would a cash out refi be a good strategy to pay off the HELOC?


      1. Hi Johnny,

        What we did in this case was use our income to pay back our HELOC. Basically, the amount we would have saved instead went to paying back the HELOC. So, in the long run we could have saved the same amount and in a year bought a house but instead we were able to buy a great house a year earlier because we had access to the money. You could also use a portion of the cash flow to pay back the HELOC.


    2. You mentioned in the article that there is a 10 year draw period and a 20 year repayment. In your case, since you plan to always pay the HELOC back asap (and lets assume at the end of the 10 years its paid in full), does the HELOC just end at that point and you have to apply for a new one? Or are you able to extend it again, or how does that work?

      Also, does the HELOC increase with the equity in the home? For example, if you have a HELOC for 5 years you have now paid down the principle on the property secured by that HELOC. Does the HELOC increase by that principle paydown? Or is it simply whatever it was when you opened it?  


    3. Hello @Elenis Camargo..  just found your article on HELOCs.. great article and thanks for writing it down! I'm located in Los Angeles and currently own a couple of rentals - I'm considering to leverage one of them via a HELOC to purchase another one. I wanted to ask a couple of questions over here:     a) Did you consider a home equity loan (fixed rate), rather than a HELOC (Variable rate), and if so, why did you go with the HELOC?     b) were you concerned during the 1-year period that you had that HELOC about sudden interest increases? That's honestly the one thing that is holding me back :|   c)  I'm also seeing that you're helping investors from out of state to invest in FL. Are you doing some sort of JV with investors or finding off-market deals??  


      Thanks a lot :) !! 


      1. Thanks for reading and for your questions! A) I did not consider a home equity loan because once that is paid off, you can’t use it again where a HELOC you can use over and over again. At the time there were no fixed rate HELOCs either vs now I have heard they  are available. B) We were not very concerned because the changes of interest rates skyrocketing dramatically were very low. Especially in the market we were in with record low interest rates. If you have a plan to pay it off quickly then I’d feel safe about it. But of course know the risks going in. C) I have one partnership with an investor in Oregon where we own a property together. The other investors I act as their agent since I am licensed in Florida :) 


    4. Well written article, thanks!  This is exactly how I was able to purchase my first out of state rental in JAX, using my primary HELOC.  Agree 100% with you about having plan to pay it back fast.  Before deciding to do this, I determined how much of my W2 income could be thrown at paying if off each month (as well as my tax refund) to pay it off in 12 to 18 months.  While it does mean my cashflow will be a small negative amount for about a year, for me it was worth the ability to start now and get this experience sooner rather than later.  Like the last commenter, I'm starting to think about using a 401K loan next time and paying back myself interest instead of a bank.  


      1. Great minds think alike my friend  :)


    5. We've done something similar where instead of doing a HELOC, we have borrowed from our 401K to put together the 20% downpayment on an investment property. We'd have needed a few more months to save up the needed downpayment with going the 401k route. But, we didn't want to miss out on a good deal.


      1. That's great! Agreed that it's great to have these options so that we don't miss out on a deal we find along the way.


    6. Got a couple of questions on your HELOC strategy:

      How long did you wait for the loan on the first property to season before using the equity from it for the third? is there a minimum waiting period? 

      You mentioned if you take out the equity for a HELOC, to have a plan to pay it back ASAP, what ideas did you both have and what plan did you execute to pay it back? Did you use your own income from work or money from other investments?

      Being you have 3 properties, lets say if you wanted to go big on your 4th property and wanted to use HELOC strategy, could you tie up a HELOC together from all your properties into 1 HELOC or would you have one for each property and just use them as different sources of funds into your next deal?

      What's the plan for the next use of your HELOC?

      When will you be on a BP podcast episode?!?!?

      When you were looking through regional banks and credit unions, what did you look for and asked from them? What did you like about the credit union you chose for the HELOC? 

      Dumb questions:

      The money from the heloc taken out doesn’t affect the mortgage payments/balance you took the heloc from right? As in it won’t increase your monthly due on the mortgage? Because I saw that you wrote back in 2004-2008 it affected the mortgage payments. 

      After the full repayment of the HELOC, I assumed there was no waiting period to reuse it? 



      1. Thanks for the great questions, Glenn! Here are the answers:

        How long did you wait for the loan on the first property to season before using the equity from it for the third? is there a minimum waiting period? >>> We used the equity from property #1 to purchase property #3 so it was one year later. I think the season period is 6 months, but I’ll have to confirm.

        You mentioned if you take out the equity for a HELOC, to have a plan to pay it back ASAP, what ideas did you both have and what plan did you execute to pay it back? Did you use your own income from work or money from other investments? >>> I paid this back from my personal income. We regularly save at least that amount each month so I knew how much I could afford. We would have had that money eventually by saving but with the HELOC we were able to get the house without having cash on hand for the full down payment. So it's good to know how much you can afford before using the money!

        Being you have 3 properties, lets say if you wanted to go big on your 4th property and wanted to use HELOC strategy, could you tie up a HELOC together from all your properties into 1 HELOC or would you have one for each property and just use them as different sources of funds into your next deal? >>> I honestly am not sure. I know you can do blanket mortgages to refinance multiple properties together but I am not aware of this for a HELOC.

        What's the plan for the next use of your HELOC? >>> We will most likely use it to acquire another property with the brrr strategy, but we have no concrete plans as of yet for it.

        When will you be on a BP podcast episode?!?!? >>> Hahaha I hope soon! =)

        When you were looking through regional banks and credit unions, what did you look for and asked from them? What did you like about the credit union you chose for the HELOC? >>> I chose PenFed and I liked that their only fee was $72 for a title fee and we had to do an appraisal. I didn't ask many questions only made sure that they allowed investment HELOCs and asked about fees. I liked that we didn't have to pay any closing costs and that it was an interest only payment so if anything went wrong, we were not locked into a high payment if we couldn't afford it.

        The money from the heloc taken out doesn’t affect the mortgage payments/balance you took the heloc from right? As in it won’t increase your monthly due on the mortgage? Because I saw that you wrote back in 2004-2008 it affected the mortgage payments. >>> Correct. You are not refinancing the property. If you were then you would have a new loan with new terms. Basically a HELOC is a line of credit but secured by a real asset.

        After the full repayment of the HELOC, I assumed there was no waiting period to reuse it?  >>> Correct! We had an additional $10,000 that we never used that we could have used at any time. It's similar to a credit card in the sense that when the money is paid back, you can use it again and again.


    7. Elenis, another great deeply informative article! And I loved how detailed you were and that you've attached links to you older articles that have a connection to this deal and the HELOC. Looking forward to your next article!


      1. Hi Glenn! Thank you for always reading my blogs and providing feedback!


    8. Elenis, another great deeply informative article! And I loved how detailed you were and that you've attached links to you older articles that have a connection to this deal and the HELOC. Looking forward to your next article!


    9. Great article Elenis! Did you factor in the HELOC repayment of $1,250 out of your rental income? If so, were you able to still cash flow? I'm looking into using our HELOC but not sure how the monthly HELOC payment plays into the mix.  


      1. Hi Josi, thanks for reading our article! Yes, we factored in the HELOC payment into our monthly cash flow. The property we purchased using the HELOC as a down payment had a monthly cash flow of $122, not including the monthly HELOC payment. Because we wanted to pay back the amount we borrowed in one year we had to make monthly payments of $1,250. Then our monthly net cash flow include the HELOC payment was $122 - $1,250 = -$1,128. We paid the difference from our personal income. This month is our last payment so we will have a positive cash flow going forward. We figured this is the same as if we would have saved $1,250 each month for a year to have enough money for a down payment. Since we spotted this great house and we had the HELOC available we were able to purchase it with the intent to rehab and refinance it down the road. There was no way it would have sat on the market for a year. 


        1. We did something similar in that instead of taking money our of HELOC, we borrowed it out of our 401k. We did not have enough saved up to buy a rental property. But, when a good deal showed up, we borrowed from our 401k plus used our savings to come up with the 20% downpayment.