Best way to use equity to buy another rental?

Question

Hey guys! Question for you all: What do you think is the best way to use a home's equity to buy another rental property. The three that I know of are:

1. HELOC
2. Home equity loan
3. Cash out refinance

Which one do you think is the best and why? Have you heard any podcast episodes that go over this?

Thanks!

Brett Chandler · Answer

Hey @Brad Hassett, depending on your HELOC servicer you may be able to lock a portion of the balance, but typically the interest rate is variable on the whole balance. In terms of what to do next, it really just depends on your goals. Are you investing for cash flow, appreciation, OPM for principal reduction, etc? If you borrow against your rental, you will pay higher interest and your cash flow will take a hit. If you use the cash to purchase an appreciating asset, though, it may be worthwhile. I hate the idea of refinancing out of a 2.75% rate on an investment property, but I would probably go that way, unless you are able to pay down a HELOC balance quickly. What are the details on your primary residence?

Personally, I just refi'd my primary into a first lien position HELOC and plan to use the available balance to get started on some BRRRR investing - pay cash for fixers from my HELOC, and refi to pay myself back.

Dave Skow · Answer

HELOC on your primary home .....use it ...payit off ....use it pay it off  ..etc ..... when setting it up - get it in place  for  as  high as  possible  even if you  dont think you will use the entire limit

Nina M. · Answer

I used my HELOC once to make a cash offer for a rental home. The offer was accepted. After it was closed, I did a cash-out refi for this new rental right away to lock down 30 years fixed rate. I paid back my HELOC. My husband doesn't like to borrow too much, otherwise, I would buy another rental with the cash. Oh well.

Brett Chandler · Answer

Hey @Brad Hassett, @Aaron Byrne brought up some good things to think about. Are you talking about borrowing against your current primary residence? I would also say that it depends on how quickly you think you'll be able to move on your next purchase - the HELOC would give you the funds available without charging you interest until you use it. I love the flexibility of HELOC's, but it's not a tool I would carry a balance on long-term. I would personally rather pay a lower, fixed rate than to carry a balance on a variable rate. Your loan costs would be less with a HELOC or Home equity loan than a refi. Depending on your current mortgage, a cash out refi might give you better cash flow, with a lower single payment instead of your current mortgage as well as the HELOC/HEloan. The HELOC/HEloan would also allow you to leverage more of your equity, without introducing PMI into your equation. Hope this helps. Good luck!

Aaron Byrne · Answer

Hi Brad,

Each offer different pros/cons, so I would, do a little independent research before making your decision as you never want to invest in something you don't understand (in my opinion). Each have their place, and are good for different things.

Some differences between the 3:

1. Heloc offers the best flexibility as you can draw down and pay back balances as needed. Negatives include the potential for a variable rate. With rising interest rates projected, you may not see many lenders offering a fixed rate on these unless you convert the loan down the road to an amortized payment.

2. Home equity loans are a lump sum of cash at a fixed rate. Some negatives are that you must pay interest on the full balance right away, so you should try to have a property identified to purchase before closing so you limit your exposure as much as possible. Easier said than done in this seller's market, though.

3. Cash-out Refi is much like a Home Equity Loan, except that it replaces your 1st lien with a higher balance. This works if you have a low LTV 1st and may carry a more competitive rate considering the loan would be secured in 1st position instead of 2nd--safer for the lender.

At the end of the day, it is important to be vigilant about the amount of leverage you are using. Typically, a 4/1 ratio or 5/1 is also suggested to ensure you have enough cushion to weather the market cycles. The best way to a healthy portfolio is through strategic planning, so be sure to think through the benefits and repercussions of these debt options before selecting one. Happy investing!

Brett Chandler · Answer

@Brad Hassett, I think that sounds like a solid plan, as long as you can get a decent rate on that c/o refi. Good luck!

Shane Johnson · Answer

No problem! I’m still a student but I been reading here on and off for 10 years. Mostly on the first year then off and back on this last year. Here to learn and share. Jk, I’m just here for the votes :D

Brad Hassett · Answer

@Shane Johnson - Thank you for the clarification and your advice.  Very helpful!

Shane Johnson · Answer

@Brad Hassett -I believe he's referring to your debt to equity ratio, which is common in any business that uses debt. In my experience the bank will be looking out for you on this, on most investment products (example, you need 20% down/equity in a property, aka 5/1 debt to equity). If it is your primary home however, you may be able to exceed that, and he is advising you to exercise caution when doing that, in case we incur a significant economic correction. Home value: $550,000Loan amount: $280,000Equity: $270,000Current interest rate: 2.75%Mortgage payment: $1,600Current rate payments: $2,650

Given that information, what you both do?I am not understanding the mortgage payment/current rate payments numbers given above but: If it were me, I would consider a loan to value of 75-80%, and pull out 132,500 to 160,000. (Id probably be at 150k because its just a nice round number :) ).If principal and interest on $280k at 2.75 over 30 is $1143, and $150k @ 3.75 over 30 is $695, now your PI on both is $1838. If you can achieve a conservative 8% cash on cash on that 150k, your net is $305($1000-695) a month on that money, plus the depreciation/tax benefits and principal paydown on the new property of course. Your numbers on the existing mortgage may be slightly different, but you get the point.

Conner Olsen · Answer

@Brad Hassett I'm in a similar position. If I end up doing a HELOC and not replacing the balance quickly I will have a higher emergency fund to cover the interest payments in case rates rise too much. That is how I plan to mitigate the risk.

Best way to use equity to buy another rental?

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