Infinite Banking - My HELOC Journey
In a previous post, I walked readers through the concept of infinite banking. If you aren’t familiar with this concept, check out my post on Infinite Banking.
In this post, I would like to walk you through my journey to secure a HELOC, and how I used the equity in my house to improve my balance sheet and increase my monthly cash flow.
Before jumping into this article, my guess is that some of you are reading this and thinking that this concept is insane and highly risky (my wife was in this camp). Others are thinking this is a great idea and a fast track to building wealth and income. I think if you do this right, the answer is that it is not highly risky, but it is not a rocket ship to financial independence, either.
How is Leveraging Your House Not Risky?!?
Leveraging your house is risky! I don’t want to gloss over this fact. I would also never recommend that anyone use the equity in their house to payoff credit card debt or purchase a car. If your financial house is so out of order that you are carrying monthly balances over on your credit card, you probably aren’t financially mature enough for this.
I was only planning to use the equity in my property to invest in real estate that paid monthly distributions to me. Specifically, I intended to invest the equity in my property in syndicated real estate investments.
Why syndications and not other types of investments? I wanted to invest passively, I wanted to invest in small increments, I wanted to be able to spread my investments out over time, I wanted to invest in real estate, and I wanted to invest in assets that would be neutral to positive on my monthly net cash flows. I felt like holding onto these principles mitigated most of the risk of tapping the equity in my house for investing.
I have active real estate investments within my portfolio. From home building to neighborhood developments to single-family rental properties, I am actively managing something every day. I like the control, I like the ability to shape my own destiny, and I enjoy it.
However, when tapping into the equity of my house, I wanted an option that would bring in positive cash flow to my family if something happened to me. I also wanted to provide an income stream that was independent of my ability to find deals, independent of the local market that I lived and worked in, and I wanted to continue to build additional lines of income.
Investing in Small Increments
To be clear, the size of each investment was not small. For syndicated real estate investments, minimum investment amounts are large. My goal was to find syndicated investments with lower minimums so that I could diversify my risk across multiple geographic areas and multiple operators. I wanted to invest around $25,000 each time. This was large enough to be impactful to me financially, but small enough so that if something bad happened to an investment, it would not be a major financial setback to me.
Investing Over Time
The very fact that I was investing in smaller increments meant that I had to invest over time. Syndicated real estate investments usually don’t come along every day, especially when you are dealing with operators that you trust and have done your due diligence on.
I wanted to invest over time because I believe this insulates me from the risk of an economic downturn. Here is why: every investment I have made has had a cash flow and value add component. To add value, the operator usually intends to lower expenses, bring rent up to market rate, make improvements to increase rents even more, etc. The investment timeline to implement these measures is usually five years. If I am in year 4 of an investment and a downturn occurs, the property is already worth significantly more than when I invested in it. More cash is being generated and expenses are lower. The risk of losing this property in a downturn should be less than a similar property that is only 6 months into this strategy. My personal cash flow may be adversely impacted, but I am reasonably confident that the asset will continue to perform if it has had time to season.
By spreading investments out over time, I de-risk a downturn.
Investing in Cash Flow
I wanted to invest in opportunities that were cash flow neutral or cash flow positive when accessing my HELOC. My goal was to generate at least enough cash to cover the initial payments. Note: I wanted to cover my initial payments. With a HELOC, most banks require you to pay a certain percentage of the outstanding balance. If you borrow $100,000 and you are required to pay 1% of the outstanding balance each month, you owe $1,000 the next month. However, your next payment will go down accordingly. Pay down $1,000 in the balance (I know, I’m leaving out interest), then the outstanding balance is $99,000 and your monthly payment is now $990.
By remaining neutral to positive on net cash flow, I could use my HELOC to generate an income snowball that rapidly paid down my principal so that I could reinvest that much quicker or pay my house off in a matter of months vs. years.
Invest in Real Estate
I wanted to invest in syndicated real estate vs. stocks or bonds for several reasons. First, I believe that it is tough to find a publicly traded asset that provides enough cash each month or quarter to generate 8%-10% cash annually. Even when you find these types of investments, the dividend can always be reduced, which I saw as a pretty big risk.
Syndicated investments usually have a preferred return. This return is not a ‘guarantee’, but it does align the investor’s interest with the operator. The operator is not able to take a profit from the investment until the investor has received their full preferred return. The average preferred return that we see is around 8%-9%. While the payout on a preferred return can be reduced by the operator (and several of mine were during COVID), it must be paid out completely before profits can be split between the operator and the investor.
The final reason I wanted to target real estate was taxes. If I invested in stocks or bonds, I would expect to lose between 20% and 30% of my revenue to taxes. This would take an 8% annual return (assuming you could find this) down to a 5% to 6% return. Investing in syndicated real estate allows you to reap all the tax benefits of real estate. My tax liabilities in the first couple years of each investment have been around 0% across investments. I carry forward a tax deduction most years.
Lesson 1 – You Need Equity
The first time I dug into this concept I was disappointed to find out that I did not have enough equity in my house to do this. With a bank payment of $1,800, if I paid my mortgage off using a HELOC, my monthly payment would have increased to around $2,200 each month. It took a few more years to build up the equity I needed before I implemented this plan.
Note: I did make additional payments to the principle on my house. This is something that I have always done and will always do. I at my core, I dislike debt.
Now, I could have pulled the trigger several years ago and accessed around $70,000 in equity, but I was not comfortable increasing my monthly debt payments without having significant income coming in to match those increased payments. I wanted to be relatively conservative.
Lesson 2 – Shop Around
This should go without saying but shop around. I found that mid-sized or regional banks had the best product line for banks. The national/international banks and the mortgage companies came with longer-term loans, but the monthly payments were higher. I found that the small community banks had shorter terms and high monthly payments. Regional banks tended to offer 5-to-10-year terms and a requirement to pay 1% to 2% of the principal each month. They also came with teaser rates (1% to 2%) for the first year. After the first year the rates increased to ~4%. Some banks had fixed rates, others had floating rates.
The most competitive products came from credit unions. They offered longer terms between 20-30 years, and their payment requirements were usually between 0.5% and 1%.
Lesson 3 – Take Your Time Deploying Capital
I have followed the principles that I laid out above. I’ve kept my investment amounts low, and I have taken about five years to deploy the full amount of the HELOC. There have been a few bumps in the road, COVID being the biggest. The good news is that my investments have always been cash flow positive.
I continue to make the base payment each month that I was paying on my mortgage. Each month, I apply at least $1,800 from my household income to the HELOC. My current balance is around $230,000.
Starting in about a month, I should be earning around $700 each month in preferred returns from what I have invested. This will take my monthly payment to $2,500 which will cover the monthly amount due plus an additional $200 (my monthly payment is 1% of the balance owed).
I’ve also reached a point in the syndicated investing cycle where my early investments are either refinancing or selling. A refinance is great because you receive a portion of your invested capital back while continuing to receive your monthly preferred return (and sometimes more). These refinance events are tax free, so I can redeploy 100% of the return without having to worry about the tax implications.
Using the sale proceeds or return of capital from a refinance will yield significant compounding returns that will further accelerate the repayment of the HELOC.
A Few Final Thoughts
I am still trying to determine how much money I will use from the equity in my house to invest in syndicated investments. Long-term (+20 years), I don’t think I am comfortable using 100% of available equity in my property. However, I do think that keeping $50,000 to $100,000 on a HELOC long-term makes a lot of sense. I’m using equity to make money, and a $500 to $1,000 monthly payment is fairly small, so I wouldn’t be worried about covering that payment out of my household income.
I stay dialed in to my property value. The term on my HELOC is 10 years, and I can borrow up to 80% of the value of my house. I want to be careful that when the terms of the HELOC are due, I have plenty of equity to kick off another HELOC. There is a risk that if property values decline when the note is due that I would not be able to get financing.
Fortunately, property values have increased steadily in my area, so I have more equity in the property than I did when I initiated the HELOC. In year 7 or 8, I intend to take out another HELOC, pay off my current one, and reset the terms so that I have another 10-20 years.
I have also found the HELOC to be extremely valuable as a short-term financing solution. There have been several fantastic investments that have presented themselves, but I have had my cash tied up in other deals. Most recently, we were waiting on one property to sell (I had a lot of confidence that the property was going to sell), and another amazing opportunity presented itself. I wanted to take the cash from the sale and apply it to the new opportunity, but the timing was about three weeks off. I was able to use my HELOC as a short-term financing tool to invest in the new opportunity. Once the sale occurred, I paid down the balance on the HELOC.
There is an inherent risk in carrying debt, and I don’t want to be dismissive of this fact. However, I think with enough discipline and due diligence, you can use equity as a lever to increase your monthly net income and build long-term wealth.