Danger in Using Home Equity Line to Purchase Real Estate

[Sean Salandy]

I am planning to use my home equity line of credit that I received on my primary residence to put a down payment on a rental property. During the application process for the HELOC, I told the bank that I would be using the HELOC for home improvement. My question is, if I use the line for a downpayment for a property and the bank that gave me the HELOC finds out that I used it for real estate instead of home improvement, would they call the balance due on the HELOC(request that I immediately pay the balance off)? I'm not sure how they would find out but I'm assuming if I write checks against the HELOC, they could possibly find out that way.

[Peter Fokas]

How would they ever find out what you used it for?

[Sean Salandy]

Peter Fokas I'm not quite sure and maybe you can help me understand. If I am writing a $15,000 check as a downpayment directly using the HELOC checks they provide, is there I way they could find out that way? Now, one could say couldn't I just write myself a check for that amount and deposit it in a different checking account first and then write the check for the downpayment from the new account but wouldn't the mortgage company for the new rental property want to see that I had those funds in my checking account for several months?

[Account Closed]

@Sean Salandy "Honesty is the best policy".  :)

[Peter Fokas]

I doubt the HELOC lender will be following up to ensure you actually spent the money on home improvement. If it will make you feel better then use a very small % on actually doing some home improvement. Get a new light fixture for your kitchen..etc. This way you did not lie. I would think when you pull out money from the heloc you will initially place it in some checking/savings account. Who is actually going to directly provide a Heloc check to Home depot for purchases?

As for the second part you are right - the mortgage company will want to see you have funds and if they see any signficant cashflow inflows into your checking account that occurred in the last 3 months they will want to know where you got it from. That they do ask about.

[Sean Salandy]

Thanks Art Allen for the reply. I've inquired with several banks and they all said they would not allow a HELOC if I was going to use it to purchase real estate. That's the tough part for me.

Peter Fokas thanks for your reply as well. I will actually consider doing a few things around my home. I am in need of a new driveway. As far as using a separate account to write checks from, I will most likely do that. The only hang up is that I have the HELOC through my primary bank. I plan on opening a separate account with another bank in order to do most of my RE transactions. So, I shouldn't have a problem telling the mortgage company where I received the funds. I just always wondered about this topic.

[Brandon M.]

@Sean Salandy - just don't tell them what it is for. It is your equity, they don't get to dictate how you spend it. Just tell them "home improvements" if they ask. Once the loan is approved you can spend your money how you see fit, they don't monitor your account to see what you are buying. 

I was in a similar situation as you, took out a $75k HELOC and used that as a springboard to get my real estate investing start. It is more risky than using your own liquid cash (or someone else's funds) but if you are confident in your valuation and willing to take the risk then go for it. I would make the same decision again but I am more willing to take risks than some others might be.

[Brandon M.]

Just make the payments on time and you won't have any issues. stating "home improvements" isn't a lie, you just aren't say WHAT house you are improving! 

[Chris Vail]

@Sean Salandy I just completed my HELOC on my primary home to pay for the renovations I am completing on my first rental, the bank had no problem with doing the loan, and I just told them it was for cash reserves. Just like @Brandon M. states it is your equity, and your financial situation, if you can make the payments on the HELOC and you have the equity available you should be free and clear.  I told the bank exactly what I was planing to do and they gladly gave me the loan, and told me that they would do it under the reasoning cash reserves needed.

[Peter MacKercher]

@Chris Vail 

Good Job!!!

[Matt Morgan]

I have a home equity loan on my primary residence and the credit union had no problem with my intention to do this. 

I could see them having an issue with it if they thought buying a second home could adversely affect your DTI, but I don't think it's necessary to tell them.

[Jon Deavers]

@Sean Salandy 

Even if your bank making the HELOC is okay with you funding RE transactions with it...

Something else to consider is that if you are planning to leverage the HELOC funds as down payment on further financing, you may run into a snag when it goes to underwriting. I would be very up front with your lender when making application for a loan that the down payment is coming from a HELOC. Some institutions and some government backed finance products prohibit the down payment monies from being borrowed funds. Could save you from losing out on home inspection costs, attorney/title fees, and everybody's time if you clear that up front even if you have a financing contingency in the contract. Without a financing contingency you could even lose your EMD$.

[Mark F.]

Originally posted by @Jon Deavers:

@Sean Salandy 

Even if your bank making the HELOC is okay with you funding RE transactions with it...

Something else to consider is that if you are planning to leverage the HELOC funds as down payment on further financing, you may run into a snag when it goes to underwriting. I would be very up front with your lender when making application for a loan that the down payment is coming from a HELOC. Some institutions and some government backed finance products prohibit the down payment monies from being borrowed funds. Could save you from losing out on home inspection costs, attorney/title fees, and everybody's time if you clear that up front even if you have a financing contingency in the contract. Without a financing contingency you could even lose your EMD$.

I've been doing mortgage banking for a number of years and I can affirm that underwriters often frown upon borrowed funds for a down payment. Definitely work very close with your loan officer about this before you put earnest money onto a house to make sure you can get approved and get the deal done. 

[Sean Salandy]

Brandon M. Chris Vail Matt Morgan Jon Deavers Mark F. Peter Fokas Peter MacKercher Thanks for the responses. I feel much more confident in proceeding. I will take heed to Jon Deavers and Mark F. 's advice as far as being upfront with the mortgage company as to the source of my downpayment. I would hate to hit a snag when it comes time to close. It is reassuring to hear those that have been successful using this method.

[Account Closed]

Sean S. I guess one of us is going to have to change their name.

[Mike H.]

Typically, they ask what you are intending to use the proceeds for. But unless they actually put a stipulation in the HELOC that you are limited to using the proceeds of the HELOC for "some activity named x", they don't have any legal leg to stand on.

Thats like doing a cash out refi. They will ask you what you are planning to do with the money. But once you get the cash from the refi, they can't do anything at all to you if you use it for something else.

About the only exception might be in paying off a credit card or something. If you tell them you are using it pay off a credit card, then you might very well need to pay off the card.

But its a HELOC. The very nature of that loan is to use it to pay for something and then pay it back down. Then use it to pay for something else.

If banks were able to call heloc's due for anybody that used them for other than the initially stated reason, you'd have nobody with a heloc left today.

Again, unless you have a limited purpose heloc where the bank is explicitly telling you the funds can only be used for "x", you can use that money for anything your heart desires and the bank isn't going to do a thing - as long as you pay it. Nor do they have a legal right to claw anything back.

That being said. A bank can always reserve the right to close a HELOC. During the boom, they closed a bunch of em.

[Christian Bors]

I write HELOCs all time, probably 8 a month. And that my friend is 100% illegal! You will be caught.

Haha I'm kidding. Like everyone else said, you have nothing to worry about. In fact, with my bank, one of the reasons for HELOC can be "future need" aka it can be used for anything. As long as it there are no requirements for closing of the heloc, aka paying off credit card debt or closing out some other loan, the HELOC funds can be used for anything. Also, just deposit the funds into your checking account (preferably a seperate one for business) and then write the check to whomever. Its easier to keep track of what your spending the funds on anyways.

Good luck!

[Sean Salandy]

Sean S. You're right. We'll have to find a way to do Rock, Paper, Scissors for it.

Mike H. Thanks for the post. I figured what you are saying was true. I just let doubt creep into my head when thinking back to when a my application was previously denied when I specifically said I would be using it for RE. Now I can see I should maintain focus and continue on with my plan.

Christian Bors you had me there for a second. Thanks for your response as well.

[Jesse T.]

Was your HELOC over 100K? They may be asking for tax reporting purposes. You can deduct interest on up to 100K for anything, but beyond that it generally has to be used for home improvement.

However you can elect to treat a HELOC as if it is borrowed on the investment property you acquire - and any amount will offset investment income on the property.

[Account Closed]

@Sean Salandyseriously.  ok, ready, go!  I chose rock, did I win?

jk

maybe @brandon turner or @Joshua Dorkin can help us on this one.  And maybe at least you can put a pic up so people can tell which one of us is posting?

[Brandon Turner]

Hey @Sean Salandy and @Account Closed 

 - lol, I don't think I've seen this issue :) 

So, first, there isn't  a great way to separate the two names, unless someone wants to "unhide" their name by going to BiggerPockets.com/settings/privacy. Or, be sure that both have photos and hopefully that'll help most people figure it out! :)

[Jeff Brower]

Keep in mind that the heloc will negatively affect your DTI ratio. You want to be sure that the heloc monthly payment added to your projected investment property monthly payment do not make your DTI ratio exceed the maximum for your investment property lending institution (normally around 43% back end for most banks if I am not mistaken). I believe that the norm is for the lender to use the heloc maximum draw amount minimum payment.