HELOC vs. Cash Out Refi on First House Hack

[Lauren C.]

Hi All!

I know this topic has come up before but I read most of the past forums and those asking the question are either asking about a property they paid cash for or used hard money to acquire it. I'm in a slightly different boat.

I recently purchased my first duplex. It will be owner occupied for 1 year until I buy and relocate into another small multi. We've put a lot of money and work into rehabbing the units and I would like to free up some cash for the next deal as well as pay off a credit card we used to assist with rehab. (New card with 0% APR for another 10 months)

Here are the numbers:

Purchase Price- $117,000

Down Payment- 20%

Current Mortgage Rate- 4.875

Rehab Costs- $50,000

- We did A LOT of the work ourselves and while we haven't had it appraised yet, our realtor is confident it will appraise for at least $190,000.

I called a bunch of banks and the best rate I can find for a cash out refi is 4.2.  Lower than my current rate! In order to make the deal "work" in terms of cash flow, I would only plan on cashing out about 30k. 

So here's my dilemma that I'm sure others have.

Do I do the cash out refi, pay a few thousand in closing costs, get a lower rate, but increase the mortgage payment thus decreasing cash flow a bit. (I'd be right at $100 a door after the refi. This accounts for all expenses, repairs, vacancy, capex. I'm very conservative in my numbers for reserves.) Also, are the closing costs worth only pulling out 30k?

or

Do a HELOC which people seem to love as they can borrow and pay it back at often as they like?

Pros- No closing costs. Lower interest rate on the cash only when I use it. 

Cons- According to the banks, the HELOC rate is only locked in for 5 years and then can increase up to over 5-6% and I heard stories of HELOCs being called back with not much notice.

Overall, my goal is to pull 30-35k to pay off a credit card and use as a down payment for the next small multi.

What do you guys think?

Side question- Can I do a cash out refi AND a HELOC afterwards on the same property? Can I do both?

Thanks in advance for reading this whole thing and any advice!

[Mike H.]

Therein lies the value of the house hack. Keep buying properties as your primary residence so you can get the cheaper financing as you grow your portfolio. And yes, I believe you can get heloc's for each house.

That being said, there can be a limit for some banks on how many mortgaged properties you can have in order to qualify for their heloc. So even though fannie mae allows up to 10 financed properties, that is for first mortgages only. Some banks might not do heloc's once you have 4 or more mortgaged properties - even if it is your primary residence.

But again, some will. Just keep shopping around.

It is the cheapest money you're going to get. And if it gets to where you make a decision that you aren't going to need it, then pay them off and close them out.

In terms of credit and dti qualifications, that is definitely a consideration when it comes to heloc's. But as a landlord you should be able to use your rental income (or a portion thereof) against the payments to offset it. 

The way dti calculation works:
1) Add up your personal income  (from job)
2) Add up your personal debt payments (includes piti from personal residence - 1st and 2nd mortg)

Now calculate your net profit/loss from rental income>
Lets say you have 1 property. Take 75% of your gross rent and subtract from that your mortgage payments (1st mortg and heloc) and taxes and insurance. If its positive, then you have a net profit - add that to your personal income. If negative, then add that to your personal debt payments.

Then divide personal income and debt payments.

i.e. 3,000/mo personal debt divided by 8,000/mo personal income. = 37.5% DTI.

Now say your rent is 1,600/mo on your one property. Your PITI (incl 1st and heloc) payments are 1,000/mo. Take 75% of 1600 (1,200) and subtract 1,000. Gives you a net rental income of 200/mo.

So now your dti calc is 3,000 personal debt divided by $8,200 personal income = 36.5% DTI.

If your rental profits are good, your rental income will IMPROVE your dti - not hurt it.

The keys though are:
1) Some banks require 2 years of landlord experience before they'll count your rental income. If so, then you'd probably need to look for another bank. Most will count it right away unless you're buying 10 houses a year or something.

2) Make sure they calculate the dti this way. Some banks will try adding your 75% of rental income to the personal income side and the PITI to the personal debt side and then doing the division. Thats WRONG! But many underwriters are simply inexperienced in dealing with investor income so they'll think that makes sense. If they read the fannie mae guidelines, they'll see they're wrong.

I only mention it because I've had to deal with it on several occasions and it really does make all the difference in qualifying for the loan or not. If they calculate the dti based on the guidelines, you'll be fine with the rentals. If they don't, you wont. :-)