Financing through HELOC

[Rheis Cloutier]

I have been considering for a long time investing in multi units. When I first started looking, I looked for a few years but just ended up buying a single family home that I currently live in and have for multiple years now. Lately I have been hearing a lot about his method of using a HELOC loan and using the proceeds from that as a down payment for multi units. Due to the rise in home prices, I have a fair amount of equity in my house and was considering this method. I was hoping that someone could explain this method a little more in detail as I have really only heard the few soundbites on Facebook Reels and whatnot. If I were to do this, which I don't plan to for at least a few months (I would like to properly do my research) I was also curious whether or not people thought interest rates on HELOC LOANS were going to start going down or continue going up? Most likely with the Fed cutting rates, at least historically, the rate cut has led to a recession which usually leads to lower interest rates in an effort to jump start the economy. I am just curious what people are predicting. Also if anybody has any suggestions on books to read on the subject of HELOC financing or any similar methods I would greatly appreciate those recommendations as well!

[Jason Wray]

Rheis,

As a banker I struggle to see why most people will choose a Heloc over a cash out refinance. There are many reasons why a cash out refinance is the better choice but there are a couple of reasons a Heloc can be used. One objection that is common now a days is the first mortgage rate being low and the home owner not wanting to lose that low first mortgage rate.

The other objection is they want to use the Heloc like a credit card only making a payment on the portion that they use rather than the full amount. Those are both two valid reasons but if the funds are being used as a down payment to buy another home. A cash out refinance will typically be the better choice for a few reasons.

A cash out refinance allows for a longer term 30 years versus a Heloc usually over 10 or 15 year term. A cash out refinance offers a lower rate versus a Heloc so a longer term and a lower rate equal a lower payment. A Heloc can "Never" be used as a "liquid" or PITI reserve which is required to buy investment properties. A cash out refinance puts the cash into your bank and can be used as PITI reserves or as an asset.

A Heloc becomes another trade line on credit which can potentially cause a higher DTI and lower your chances for future approvals. I have seen a Heloc lower an investors scores due to excessive tradelines and due to the balance to credit limit percentage. When you take the cash out through a refinance its your money tax free and it cannot be taken back. When you take out a Heloc it can be closed or the limit can be reduced for any reason at any time.

If you go late on a credit card, missed payment, credit score drops the bank or lender will in fact lower the credit limit or close the Heloc due to risk. I have seen a lot of investors get stuck with a Heloc that they opened up and due to a small mistake find out the bank cut their heloc limit in half or in some cases closed the account leaving them with a balance to be paid off before they could even finish a renovation project.

Heloc rates are much higher right now versus a 30 Year cash out refinance by over 3-4% in some cases higher depending on credit score, CLTV, and loan size. Heloc rates have not moved since the FED rate cut but mortgage rates are down over 1.25% since July.

You have to also consider that over 85% of people who take out a Heloc end up doing a refinance in 3 years to consolidate the Heloc into one mortgage.  It does come down to a set of specifc details based on the owner, new purchase price, and a few other things.  If you have any questions at all feel free to reach out I am always happy to help offer advice and tips.

[Nathan Gesner]

Your equity is not a savings account from which you can withdraw for free. If you cash out equity in a property, you are "borrowing" that money from the lender. Upfront expenses and monthly payments must be considered when calculating the return on your investment.

EXAMPLE
You cash out $100,000 of your equity and use this as a down payment on a $400,000 investment property. This creates two loan payments ($100,000 of equity and $300,000 on the new mortgage).

Key Numbers

• Home Equity Loan Interest Rate: 6%
• Mortgage Interest Rate: 7%
• Rental Income: $3,000 per month
• Expenses (management, taxes, insurance, maintenance): $800 per month

Income and Expenses

• Monthly Rental Income: $3,000
• Monthly Expenses: $800
• Monthly Mortgage Payment: $2,000

Explanation

• The investor earns $3,000 in rent each month.
• They pay $2,000 on the investment property mortgage and $800 on other expenses.
• This leaves $200 profit each month or $2,400 per year.
• However, you have to pay $6,000 interest on the equity borrowed.
• This leaves you with an annual loss of $3,600.

This example shows that while the rental property generates positive monthly income, the interest cost of borrowing the initial $100,000 results in an overall annual loss. The investor must consider whether the potential property value increase or other benefits outweigh this loss.