Cash out refi or HELOC?

[Madison Heck]

Hi all! I am close to purchasing a property in upstate New York with a friend. We are planning on employing the BRRRR strategy and want to outline what our plan is for generating capital for the down payment of our next property (and each one after that).

We are planning to put 20-25% down on this first property, then are debating whether to refinance for cash or take out a HELOC on the first property.

Which option makes more sense for us in your opinion? And is there any amount of time that we will have to wait after we close? I'm seeing 6 months for a refinance in a few places but also that it depends on the lender.

Any help is appreciated! Thanks

[Jaysen Medhurst]

Are you asking about the return of your initial capital, @Madison Heck, or something beyond that? If just the return of initial capital, go for the long-term cheap traditional financing. Sharing your numbers may help us better understand.

[Madison Heck]

@Jaysen Medhurst I'm asking about the best way to sustain cash flow in the initial property while pulling out cash to use as a down payment on another property.

For the purchase of the initial property, we'll use some example numbers.

$200,000 property value

We would put down $50,000 (25%) + closing costs and have the rest financed by a 30-year mortgage from a bank.

What would be the best way to pull money out of this deal in order to finance the down payment on the next property that we want to purchase? Hopefully while also maintaining decent ROI for the initial property.

Hopefully this phrasing makes a little more sense :) 

[Jaysen Medhurst]

Based on what you wrote, this isn't a BRRRR, @Madison Heck. A BRRRR would look something like this:

• Buy a duplex for $125k, 20% down ($25k)
• Rehab for $25k
• Rent out each side for $1k/month
• Refi based on new appraisal of $200k, 75% LTV ($150k mortgage)
• Repeat using the return of your initial $50k of capital

What you're describing sounds like a straight-ahead buy-and-hold investment. There is no way to pull out capital without adding value or waiting for appreciation and mortgage pay down to increase your equity. A lender will always want you to have at least 20-25% equity in an investment property.

[Madison Heck]

@Jaysen Medhurst The situation I outlined was one in which no rehab would be required, so yes I agree that would be more buy-and-hold.

We were planning on putting rehab into the property, but I wasn’t sure the scale of it. It seems like the larger rehab to push the property value up significantly is the defining piece of the first R.

Seems like i have my answer, thank you!

[Madison Heck]

[James Perdomo]

@Madison Heck i would do a HELOC as you wont have to pay it back when its unused. It wont affect your cashflow if you dont use it during your search for a new prop. If you cash out you will have the monthly obligation and will affect your bottom line whether you use the money or not. I personally like LOC's more than cashing out.

[Madison Heck]

@James Perdomo Interesting, it seems like that would be a better deal in general than a refinance. What are the drawbacks of a HELOC in comparison to a refi?

[Samuel Reznikoff]

I'm actually in the same position as you! I'm in the process of Refinancing down my first House Hack from 4.6% to 3.2, and the appreciation means I can grab an additional 15-20k out of the deal. However, reaching out to my credit union I was told I'd also qualify for a 40,000 dollar line of credit! Decisions decisions. The decision came down to your current capital. I'm small with only 2 properties and 20k cash to my name at this time . I opted for the line. That way, I can have almost 60,000 at my disposal to hop on a deal vs 35k.

How impact will the cash in hand be vs the access to potentially more capital in your scenario?

[James Perdomo]

HELOC will usually have a floating rate which fluctuates, while a refi you can lock in a very low interest rate for a long term. There is a period with some HELOC's that give you say 5 years to pull from the draw, then makes you repay what you used in those years. I personally haven't done a refi and have only utilized business LOC secured by a rental that i bought all cash. Both have their benefits and it depends on your factors which would be best. Hope this helps!

[Jimmy Lieu]

Originally posted by @James Perdomo:

HELOC will usually have a floating rate which fluctuates, while a refi you can lock in a very low interest rate for a long term. There is a period with some HELOC's that give you say 5 years to pull from the draw, then makes you repay what you used in those years. I personally haven't done a refi and have only utilized business LOC secured by a rental that i bought all cash. Both have their benefits and it depends on your factors which would be best. Hope this helps!

Hi James,

Great answer! I am learning more about HELOCs at the moment. I understand there's a draw period and repayment period. During draw period, I can use the HELOC like a credit card which I can borrow and pay off the debt and interest is due only on what is borrowed. I understand the draw period pretty well.

However, I am a bit confused on the repayment period. Once this period starts, I can't use the HELOC like a credit card where I can borrow and repay anymore? And instead, I need to repay the ENTIRE heloc amount borrowed? With interest on it? Where do I figure out the interest rate on the repayment period? Or is it the same as the mortgage interest rate?

Thank you so much in advance


 

[James Perdomo]

Originally posted by @Jimmy Lieu:

Originally posted by @James Perdomo:

HELOC will usually have a floating rate which fluctuates, while a refi you can lock in a very low interest rate for a long term. There is a period with some HELOC's that give you say 5 years to pull from the draw, then makes you repay what you used in those years. I personally haven't done a refi and have only utilized business LOC secured by a rental that i bought all cash. Both have their benefits and it depends on your factors which would be best. Hope this helps!

Hi James,

Great answer! I am learning more about HELOCs at the moment. I understand there's a draw period and repayment period. During draw period, I can use the HELOC like a credit card which I can borrow and pay off the debt and interest is due only on what is borrowed. I understand the draw period pretty well.

However, I am a bit confused on the repayment period. Once this period starts, I can't use the HELOC like a credit card where I can borrow and repay anymore? And instead, I need to repay the ENTIRE heloc amount borrowed? With interest on it? Where do I figure out the interest rate on the repayment period? Or is it the same as the mortgage interest rate?

Thank you so much in advance

Jimmy, 

I assume the it varies per institution how repayment works. As mentioned, the product i am currently using is a short term LOC and is evaluated every year by the lender. A HELOC on a personal residence would be completely different. I would schedule a free consultation with a local bank who can provide more clarity. It took me calling about 30 different banks that offered what i was looking for.

[Jimmy Lieu]

Originally posted by @James Perdomo:

Originally posted by @Jimmy Lieu:

Originally posted by @James Perdomo:

HELOC will usually have a floating rate which fluctuates, while a refi you can lock in a very low interest rate for a long term. There is a period with some HELOC's that give you say 5 years to pull from the draw, then makes you repay what you used in those years. I personally haven't done a refi and have only utilized business LOC secured by a rental that i bought all cash. Both have their benefits and it depends on your factors which would be best. Hope this helps!

Hi James,

Great answer! I am learning more about HELOCs at the moment. I understand there's a draw period and repayment period. During draw period, I can use the HELOC like a credit card which I can borrow and pay off the debt and interest is due only on what is borrowed. I understand the draw period pretty well.

However, I am a bit confused on the repayment period. Once this period starts, I can't use the HELOC like a credit card where I can borrow and repay anymore? And instead, I need to repay the ENTIRE heloc amount borrowed? With interest on it? Where do I figure out the interest rate on the repayment period? Or is it the same as the mortgage interest rate?

Thank you so much in advance

Jimmy, 

I assume the it varies per institution how repayment works. As mentioned, the product i am currently using is a short term LOC and is evaluated every year by the lender. A HELOC on a personal residence would be completely different. I would schedule a free consultation with a local bank who can provide more clarity. It took me calling about 30 different banks that offered what i was looking for.

Oh it varies by the institution, that makes more sense. Thanks so much for helping clarify! 

[Jay C.]

Are cash-out-refinances hard to get right now? I imagine a HELOC is a little easier to get atm but I don't know, I am curious what people's experiences are with that.

Getting a HELOC to help finance down payments would be interesting. Use a HELOC to pay for a down-payment then pay back the HELOC with cash-flow, then repeat. Is that a common method for financing new houses?

[Madison Heck]

@Samuel Reznikoff That's great! Sounds like you're in an awesome position.

In my case, the more capital to take and put down on other properties, the better. We will need to pay off our rehab on the initial property as well, but I'm not sure if cash or credit would be better for that.

[Madison Heck]

@James Perdomo The floating rate is what scares me, especially right now/in a few months. I feel like I will want to lock in a rate with the outlandishly low rates right now that I imagine will slide down a bit as well. The refinance would do this for the forseeable future.

I see the draws of the HELOC though, this will be a difficult decision!

Thanks :)

[Samuel Reznikoff]

I'm no financial analyst but remember the draw for a HELOC can be negotiated, mine being 10 years in this instance. I bumped it from 5 by just a few short sentences, 15 would add 1%. BUT, that also means anything I start spending on now during my draw period, I'm betting on rates being realistic 10 years down the line, not foreseeable future.

Each have risk appetite that is different, but don't let banks talk you into the shortest draw, you always always ALWAYS have options :) 

[James Perdomo]

Originally posted by @Madison Heck:

@James Perdomo The floating rate is what scares me, especially right now/in a few months. I feel like I will want to lock in a rate with the outlandishly low rates right now that I imagine will slide down a bit as well. The refinance would do this for the forseeable future.

I see the draws of the HELOC though, this will be a difficult decision!

Thanks :)

My LOC floating rate since summertime last year has fluctuated from 5.75% to 4.25% annually on the amount I've used. But as i mentioned, both have their benefits and using them appropriately will inevitably lead to wealth!