Payoff HELOAN used to buy rentals?

Question

Any advice here appreciated. In the last few years I took out a HELOC on my primary residence, used the funds for the down payment on two investment properties, then refinanced the HELOC into a 30 year loan (7/1 ARM) as a second mortgage against my primary res. In essence I financed two properties at 100%.

The rental income minus the mortgages has me in the red around $450 a month. If I paid off the ARM, I would flip to black cash flow around $450 a month. Question is should I pay off the down payment loan (7/1 ARM) early or put that money into savings and just refinance the ARM at end of the term? I don’t currently have the money to just pay it off but considering if I should attack the loan over the next few years or save liquid funds for future deals.

Jason Wray · Answer

German,

You absolutely have a couple of good points and like the saying "to each their own" its for some and not for others.  My main critique is in the "Majority" of the cases you and others who will take out a Heloc will eventually refinance to consolidate it into one loan/mortgage.  So essentially depending on your timing you will need (2) things in your favor to do that lower rates, and enough equity.

In some cases having an interest only rate is not a good thing because it can and it does create comfort which can lead to bad habits of not paying the principal down.  I have seen thousands of home owners over the years get stuck with an I/O Heloc and cannot refinance it due to lack of pay down and not enough equity/appreciation.

You still have a 30 year mortgage at low 6% versus a Heloc in todays market at over 8-10% over a shorter term 10, 15, or 20 but never 30 yeas so in most cases the mortgage payment is less.  Unless you have a small credit union where you have all of your liquid reserves/cash and they give you the standard I/O teaser rate on an adjustable rate.

Emanuele Mayer · Answer

Hello Jonathan if you investment property gained equity would be a good idea to cashout refi those and pay off the Heloc, of course we have to check the scenario and analyze your specific situation.

German E. · Answer

Hi Jason,

Sorry for taking a while to respond and thank you for your comments, it's great to hear the opposite opinion on this.  It does seem that rates are going down, and at some point like you say we will end up refinancing to a perhaps somewhat larger rate on a 1st position mortgage to consolidate.

In the meantime, I'm still more positive on helocs and heloans than you are.  For one thing, if after getting a heloc your property appreciates, you can always refinance the heloc to a larger heloc, even with the same bank, no need for 3rd position loans.  I have done this myself multiple times.

Helocs (as opposed to heloans) are interest-only for a period of time, usually 10 years, so during that time the monthly payment is lower on a DTI calculation than a first position mortgage with the same balance.  Long before you reach the 10 year mark and start making payments, you can refinance your heloc and start over if needed, as long as the equity has not decreased.

What if you have a heloc at $0 balance and are not using it?  You mentioned an underwriter will use the maximum payment for DTI purposes, and I have had this as an open question for a while.  Now I'm in a position to answer it, as I had an existing heloc at $0 balance and just last month went through qualification for other loans.  I asked two different loan officers (one at a credit union and one for a conforming mortgage loan), and they both said that if you're not borrowing from the heloc, it doesn't increase your debt or your DTI ratio.  They seem to look at it as the balance you have on a credit card - it doesn't increase debt if you're not using the funds.

So there - I don't think helocs are a long term solution, but until we get to the point that rates are sufficiently low, we can use them to get equity from homes and continue to grow our portfolio.

Jason Wray · Answer

German,

I can see how it might not make sense but my 18+ years in the Banking business has shown me (3) cycles of this very same market.  Also rates are already coming down as of last week rates on DSCR are hitting 6.75%, FHA hitting 5.875%, Jumbo Rates hitting 6.25% where 3 months prior those rates were 1%+/- higher.

Those rates are for A/B paper but still coming down and margins on the MBS looking a lot better.

Reason I say "NO" to any Heloc if its for a Down payment or over $150K is because Heloc rates will remain higher and the terms are always under 30 years versus a mortgage.  Those two things will result in higher payments and decrease cash flow.  You also have another fun tid-bit that over 85% of people who take out a Heloc refinance in 3-5 years to consolidate or they must in order to pay off heloc to borrow more money.

You cannot have (3) loans there is no way a bank or lender is going to take 3rd lien position.  So you have to refinance to take out cash after you have exhausted your line of credit and reduce rate and go back to one loan.

Lastly a Heloc will "Never" act as an asset or PITI reserve so if you fail to have sufficient funds required in reserves (Cash) then your will not buy multiple investment rentals.  A heloc is an open end debt that hurts your DTI and can decrease fico scores.  You are also at the mercy of a perfect pay history and to service companies that if a payment is ever late even by accident.   That bank/lender who holds the Heloc will reduce your credit limit and close the account until paid and scores improve.

Cash out refinance is tax free, allows you to have higher liquid reserves, PITI reserves for multiple investment rentals, be cash strong for earnest or for a quick "All Cash offer".  It also makes you look stronger in underwriting and for the approval for more investment purchases.  A Heloc is looked at as a liability and the underwriter "Must" use the Maximum payment even if you have not used the Max Heloc amount.....

German E. · Answer

Congrats @Jonathan Joyce for a killer 2.25% mortgage rate on your primary residence - I would definitely not touch it.  I also more generally disagree with @Jason Wray's advice to cash out refinance, on two counts.  First, if interest rates do come down in a few years, then so will the rate on the heloc.  I remember paying around 4.5% on my heloc around 2021, which beats any fixed rate one can get now.

Second, it's not at all clear that rates will go down to around where they were before 2022.  Central bankers like to talk about the so-called neutral rate of interest, R-star.  This is the rate that neither stimulates nor contracts the economy.  For various structural reasons people think this rate is higher than it was before, so that the "new normal" would be at a higher level.  If so, we might never go back to the rates we had back before 2022.

Jonathan Joyce · Answer

So the 7/1 is only one year old. I do have mortgages on both properties that i used the down payment loan for. Those properties have appreciated but not enough to cash out anything at this point. My primary res is in a 2.25% fixed so a refi is not feasible for it. I am realistically looking at 2-3 year plan on paying down the ARM or just stockpiling cash with the plan of refinancing the ARM before the term adjusts if rates are more favorable in the next few years. For context my ARM is at 5.8, and the two rentals are financed at 4.6 fixed and 6.0 on a 10/1 ARM.

Jason Wray · Answer

Jonathan,

It depends on a few things if the 7/1 ARM is close to adjusting/recasting I would simply refinance into a 30 year fixed.  I would also pull out enough cash to go and buy more real estate to help increase cash flow.  If you have (2) free and clear rentals with no mortgages I would also encourage you to pull cash out of them while values are in favor of cash out.

I would avoid a Heloc and just do a cash out refinance the rates are lower and the terms are longer so you get a lower payment.  In a few years rates will be back to normal and you can refinance to drop the rate after you purchase a few more REI's

Payoff HELOAN used to buy rentals?

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