HELOC.. Use for cash purchase or down payment?

Question

Hello BP!!

I’m just now getting into the rental world. I’ll be getting my initial funds from a HELOC on my primary residence. I have access to about $70k. I’m looking to purchase my first investment property, looking in the $50k price range. Hopefully I can get it for slightly less.

My question is.. am I better off (long term) using the HELOC to pay cash for the property, or using it for the 20% down payment, and getting a small mortgage.

My thoughts are leaning towards paying cash, and avoiding closing costs, as well as having the HELOC and mortgage to pay down. If I pay cash, I would only have the HELOC to pay down. Also, by going the cash route, I’m thinking I could then leverage the rental (by obtaining a HELOC on that) to purchase another rental property in the same price range, and within a relatively short period of time.

Any advice/thoughts/direction on this would be appreciated.

Thanks in advance!!

Tom Shallcross · Answer

@Fred Buechel - I agree with @John Warren.  A few small points to add:

1. You mentioned "to avoid closing costs."  Yes, you'll avoid any financing fees or points, but when running your numbers, you will still have the majority of closing costs (title, appraisal, attorney, escrow...etc) when paying cash.  Just calling it out so you don't disregard these costs in your analysis.

2. You may have issues obtaining a HELOC on an investment property worth 50k.  This might have to be a straight cash refi, but do your due diligence and talk to your local lenders so you're not stuck with dead equity you were planning on utilizing.

3. If you only have 70k to play with and you're buying for 50k, you only have 20k for renovation and reserves.  Just make sure you have yourself covered for worst case scenario.  This seems tight but I don't know your specific property.

4. Make sure to account for what that HELOC payment will be in your new budget.  Also note that the minimum payment will only cover your interest payment.  For example, if you borrow 50k and the payment is $300/month.  That $300 just keeps you afloat at 50k.  If it's in your gameplan is to pay that down, you need to account for a greater monthly payment.

Go get em!

John Warren · Answer

@Fred Buechel if you can pay cash on a property that doesn't need a ton of work, and then you can get a tenant quickly I would go that route. The problem will probably come if you have trouble getting rehab done, you go over budget, etc. A lot of this is market dependent, and in the western suburbs of Chicago where I live and work the $50,000 wouldn't even get the rehab done on most of the deals that I see... much less buy the property!

Whatever you choose to do, be 100% certain that the HELOC money is safe and that the investment is a sure thing. There is nothing wrong with betting on yourself by using all your equity, but make sure you are not taking a huge risk. Do your due diligence, etc.

Joe Norman · Answer

I want to second this 2nd point that Tom made.  Be sure that you have a bank/lender on board who is committed to doing a cash out refi/HELCO on such an inexpensive property.  In my market the lenders who will look at sub-$100k loans are few and far between.

Martin Neal · Answer

@Fred Buechel I currently employ the same strategy you are talking about. I usually buy properties that are under $50K that traditional banks won’t lend on, and implement the BRRRR strategy (buy, rehab, rent, refi, repeat). Even if I leave some money into the deal the Cash on Cash return is higher than the interest rate of money borrowed from the HELOC and the property repays the debt. Further, the benefits of getting HELOC’s vs a traditional mortgage is you can pay down the debt quicker and pull the money back out whenever you need to.

Martin Neal · Answer

@Shannon Threlkeld In a perfect world and if it’s a great deal, when you BRRRR, you want to get all your money out of the deal. For example, buy for $30K, rehab is 20K, appraises at $100K, you acquire a loan for all your money in, let’s call it $55K. You just acquired a cash flow producing asset without having to leave any money into the deal.

If you read my post on “My First BRRRR: Success or Failure??” I had left $13K into the deal. BRRRR Is a better way to acquire rental properties without using as much of an down payment. Nothing is wrong with leaving money into the deal but if you could acquire 10 properties using the same money over and over again or had to put 25% down for every property you brought which would you rather do?? Eventually your going to run out of money for the 25% and have to wait a while to rebuild your cash.

Shannon Threlkeld · Answer

How do you mean, “leave some money into the deal”?

Thanks.

Fred Buechel · Answer

Thanks Tom.

On a cash purchase, there is no appraisal, I'm a realtor, so I don't need an attorney, no mortgage, so no escrow, and the seller pays title. Therefore, none of those fees apply if I'm paying cash for the property. The only closing costs would be pro-rated taxes and a small closing fee charged from the title company.

This would save me approximately $2,500 per purchase on a $50,000 home, per my lender. Granted, the $2,500 would roll into the mortgage, so it would essentially be paid by the tenants.

The flip side is, on a financed purchase, I would be able to dip into my HELOC for the down payment on multiple properties (in the $50,000 range), and have multiple small mortgages, but they would be paid down by the tenants. Not sure what the cash flow difference would be on multiple small loans VS one large HELOC payment if I purchased one property with cash.

Hope that's not too confusing.

HELOC.. Use for cash purchase or down payment?

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