Should I Use My Primary Home Equity for the First BRRRR Project?

Question

Hi Folks!

I’m a newbie investor and have been a big fan of BP. I’m moving to a new home with a conventional loan by the end of the year and planned to rent out the current one. My question is how I can pull out my current home equity without affecting my DTI, and use it as capital for my first BRRRR project? Will HELOC work better than Home Equity Loan in my situation? Any advice would be greatly appreciated 😊

Ke Nan Wang · Answer

We snowed ball our operation with HELOC and commercial LOC so we are a little biased towards HELOC than home equity loan. Just list some top pros and cons for this two so you can decide:

HELOC:

Pros:

1. Low/no closing cost. We opened up our HELOC when our bank had a promotion that they cover the closing cost for a line <$250k. So we opened a line at $250k with no closing cost and ready to go when deals come.

2. No pressure for spending. If we don't see a deal, we don't have to spend the money and we pay zero interest. This allow us to be more patient.

3. Lower pressure on cashflow. If you make more money, you can paydown your principle. If you make less money, you can just pay interest only.

4. Ability to reuse your capital. You can paydown principle and reuse them in a draw period. If it's a loan, it's an one-time cash out deal.

Cons:

1. Higher and Variable interest rate. Currently the prime rate is so high and the HELOC interest payment has a huge impact to our bottom line. Typically HELOC rate is always a bit higher than Home Equity Loan rate.

Home Equity Loan:

Pros:

1.Fixed Rate. Depend on the time you locked your rate in and this could be good or bad. But if someone locked their rate in at low 2%, now they are probably the most happy people on this planet. Currently you probably can get the rate around 6% where HELOC is floating around 8-9%.

2.Higher LTV. Depend on the type of loan you are getting, I did a cash out refi on my primary residence with a VA loan and got 90% LTV at a low 2% interest rate last year.

Cons:

1. Closing cost. You would probably have to pay about 2%.

2. Pressure to deploy the capital. The moment you close the loan, you are starting to pay interest. And there will be always something behind your mind to tell you that you need to make better returns, which may lead you to jump into something hastier than you would have liked.

3. Higher pressure on payment due to a mortgage payment. You will have to make PI payments every month no matter what. Unlike a HELOC your only obligation is interest payment during the draw period. Less flexible.

4. Cannot reuse the money. It's an one-time cash out deal. So you can't reuse the money that you put into the previous payments unless you do another refi, which is more closing cost.

These are the pros and cons I could think of and hope they help you with your decision.

Jason Wray · Answer

Stephanie,

If you are going to buy another home avoid a heloc they are a DTI burden.  The underwriter will hit you for the full payment of the heloc even if you do not have it used.  It's looked at as a debt obligation where a "Cash out" refinance is cash in hand and can be used as an asset.  Cash out refinance can alos help the next purchase by showing liquid reserves that are required for PITI reserves.

You also have the peace of mind of not having the bank holding the Heloc closing or reducing the Heloc because something changes.  That could be a change in your credit score, additional liabilities, higher credit card balances, or late payment.  The bank can also close or reduce Heloc balance if they are going through a hardship or having financial issues.  Normally that would not be likely but banks are struggling right now to stay a float with tighter asset and financial requirements.

Cash is king and having cash in hand and not in the form of a second lien position or excessive tradelines as a debt goes a long way in your underwriting approval.

You are right, now is the time to borrow against a primary and buy more real estate.  Rates might be high right now but they will be back down come end of 2024.  Then you simply refinance and lower the rate allowing for more cash flow.

Mike Klarman · Answer

Put the investment property in an LLC and then do a cashout refi and pull the money out.  It should not affect your DTI.

DSCR loans are Debt Service Coverage Ratio. They are just that, the ratio between the loan payment and the rent.  Most lenders want to see a 1.1/1 ratio but of course the higher it is the better the cashflow.  Most Lenders use the market rent of the area as the rent number.

EX:  Let's say the market rent for this 200k house came back as 1500/month.  That means your max loan payment can only be 1500/1.1 = 1363.  So then they have spreadsheets that then pull up the choices for leverage and rate that equate to a payment of $1,363/month.  The lower the rate, the higher the leverage if the DSCR is tight.  If the DSCR is like 1.3 then you'll get max leverage at every rate.  You get presented a chart.  There's a par rate and then there is a buy down rate.  Sometimes you have to buy down in order to get a proper DSCR and sometimes the loan makes sense at the par rate.

This is my day job, I over see loans all day long for a HML so if anyone ever had any questions let me know.  I know they can seem tricky but they are not really once you go through it once or twice.

Stephanie Joe · Answer

Hi Doug,

I appreciate your advice. I hesitate to take risk because I feel financially obligated to my family. Meanwhile, I’m highly motivated to take actions in real estate. You’re right, I have no experience so I have to think it over. I’m so lucky receiving great advice from investor as you!

Stephanie Joe · Answer

Hi Ke Nan,

Your advice is incredibly helpful! I really appreciate your time and knowledge, will consider the pros and cons carefully before making any decision.

Doug Smith · Answer

We've lived in our home for 22 years and we've built a ton of equity. We do use a HELOC to fund flip projects. I wouldn't use it for a long-term hold property, but to do a flip might work. That being said, it is a risk. We made the majority of the mistakes in our first 10 deals. After that, it became like a machine and risk really dropped. If you're on your first deal, trust me, you're in for a lot of surprises. Give it a lot of thought before you risk it all on the real estate roullette wheel if you don't have a partner that is involved with a great track record.

Jon Kelly · Answer

@Stephanie Joe why does your DTI matter that much? Take the loan for property #2. Then, refi cashout of property #1. Even if that negatively impacts your DTI, who cares?

You'll have funds for your first BRRRR project and you'll be off and running.

If DTI is ever an issue you can look towards commercial (investor) loans. Reach out to private lenders for fix and flip or DSCR loans.

Stephanie Joe · Answer

Hi Jason,

Thank you so much for your detailed advice. I’m so excited for my first BRRRR in the near future, and mentally ready to learn by making mistakes.

Should I Use My Primary Home Equity for the First BRRRR Project?

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