Pledging/Assignment of Collateral???

Question

Hi,

I have talked to my banker a bit more in regards to a couple of properties I have looked at, analysed, and am interested in making offers on.

For a bit of background, I am short on 'liquid cash'.... it's all tied up in either my ROTH IRAs, SDIRAs, a Life Insurance Policy, or the home equity of my primary residence that is paid for and listed for sale right now, partially so I can downsize and use some of the built up equity to invest in more buy and hold rentals. So with that being the case, I am having trouble coming up with the 30% down payments.

I prefer to do these deals outside of the SDIRA, as they are not 'expensive enough' to get non-recourse financing. We also prefer not to do a withdrawl from the Life Insurance Policy directly for a couple of reasons; the cash value came from a large gift from a family member, and while they are still alive, we would prefer to not tap the basis in there, and it is making about 5% after paying for the cost of insurance for 800K in coverage, etc..... I could do a loan against the policy, but it is currently about 8% interest.

So it looks like my best options are either a HELOC on the house that is for sale at about 4.5%, or to do the pledge/assignment of collateral with the collateral being the Cash Value of the Insurance Policy. My understanding is that on they will lend 100% of purchase price this way. For instance, property #1 that I am looking at would be 60K all in, which normally would need a 18K down-payment and they would finance 42K. In this case, they would finance the whole 60K, and I would need to 'assign' 18K worth of the Cash Value of the Insurance Contact.

What would be the 'pros and cons' of the HELOC vs 'assigning the collateral' in this case? It seems the assigning would be a better way to go, but thought I would ask all you experts to find out what I am missing :). Other things to consider are that why I sell my primary residence, I am likely to pay that assignment off with some of the proceeds, and likley try to finance it into a longer term product after seasoning it.

Thoughts?

Thanks, Dan Dietz

Account Closed · Answer

The HELOC doesn't not sound like a viable option if you have the property listed for sale unless the loan will be less than the amount of equity you intend to invest, i.e. the HELOC will come due when you sell and you will have to pay it off at the closing table to convey clear title. So, if you have sufficient equity to pay off the HELOC and pay for your next house, etc., then you're fine; otherwise, it likely won't work.

Steve Babiak · Answer

Do you have any stocks, bonds or mutual funds that could be pledged instead? Maybe Bill Gulley can offer other suggestions.

Bill Gulley · Answer

Adam made a good point I failed to mention trying to see a bigger picture, you've put my concerns to rest! Then use the HELOC, you may need to take it off the market awhile but your banker may go ahead and make one. A loan from life insurance is nothing more than borrowing the cash value and benefits, from a mutual company additional paid up insurance, from a stock company any stock value accrued, if any. There are hybirds as well, so the type of policy depends but really; it's from your life policy, there is no other collateral. Any default simply reduces your coverage, it could terminate a policy, so if you're uninsurable that could be an issue. A loan from your insurance policy would not count against your DTI as repayment is not required, it's basically taking the equity out of your policy. There is no use of funds requirement from insurance proceeds or from your HELOC. HELOCs can change on you, look to the terms closely. The loans can be changed charging more in interest if your credit risk changes. That's not just saying that if your credit score drops, it also means if you become financially leveraged to a higher degree, your outstanding debt increases can effect your credit risk. If you credit standing significantly changes they can call the amounts outstanding due. They can cut off future advances and drop the line of credit all. together. In reality, you won't hear a lender going there, but they can. This is the reason I don't care for HELOCs. Your strategies may need to change, look to seller financing. You might consider multi family and these investor/sellers are more receptive usually to seller financed deals. Look into the advantage for sellers and deferring gains from the sale up to $5M! Creative financing comes from the use of other assets that assist in leveraging your acquisition and or the operations of your business. Almost any asset can be pledged, unless restricted by law as your retirement accounts are. If you have accounts receivables or contracts from you operations your bank may factor those, basically an advance or loan on such accounts. Cross collateralization my be employed, you can give a seller a second on another property to sweeten the deal on a seller financed transaction. Then obviously, you need to slow or stop your contributions to the retirement accounts. Trim expenses, look to your use of funds, equities held that can be assigned and creative ways to acquire control of properties as well as title. Speaking of insurance loans, many insurance companies offer home equity loans and standard mortgages. Your insurance agent may have some options on your primary home. These will be collateralized by the home and default will carry the usual risks. :)

Daniel Dietz · Answer

Having taken a bit more time to read over this thread, I wanted to clarify my main question. That questions is; What are the 'Pros & Cons' of assigning the cash value of the Life Insurance vs doing the HELOC on my primary home? I have done HELOCs before for non real-estate uses and understand them well. I have NOT done an assignment before, so that is new to me. My banker makes it sound pretty cut and dried as long as I dont default ;-). Dan Dietz

Daniel Dietz · Answer

Bill, Luckily, I have done pretty well with both my retirement accounts and personal real estate. The reasons are several fold that I have diversified into rental real estate; I am seeking higher returns than what stocks have been bringing on average, and more stability also. I also like the idea of more easily being able to leverage the dollars I have to work with in real estate. I do have one duplex that I bought with my SDIRA, and it should yield about 15-18% as an 'all cash' purchase within the SDIRA. As far as experience goes, I work in the construction industry, so know the 'building side' of things quite well. A relative who is also an employee of mine is somewhat my mentor; he has about 10-11 units, and has been very inspirational as far as how to run things - by the book so to speak. I am in essence emulating what he does, and so far it seems to be working. One of my goals is to also build wealth outside of the SDIRA, partially because I see higher return potentials by using leverage on traditional properties. Adam, I would plan on paying off the HELOC at the time of sale of my primary home. We should come out with at least 250K free and clear, and the HELOC would only be for about 40K at most. Basically just trying to take advantage of a couple of good buys that are just on the market now that can come close to that '2% rule', which in my estimation can make good returns, instead of waiting until my primary house sells. 'fast forwarding' so to speak. Dan Dietz

Bill Gulley · Answer

Daniel, your banker is correct a security interest can not be made in any qualified tax plan. Sounds to me like you have done okay and you're on your way to a good financial position without RE. Leads me to believe you just got bit by the RE bug. What RE experience do you have? It might be a good thing that your assets are tied up, probably safer where they are than be put at risk in beginning RE deals. You may be accustom to buying conventionally, as I am, but there are other ways to acquire properties than using your money. You can also generate additional income to put back into RE. Suggesting you begin or continue your RE like most others do, set your RE business up to feed itself rather than shifting assets into that business. As to borrowing from life insurance, short term at 8% can get you one the way, consider flipping until you end up with a rental you want. The other alternative is biting the bullet tax wise from your accounts, that means your required after tax yield will need to be even greater to make up for that cost of money, a rate you may not make. I'd suggest too that you begin saving in other vehicles that don't restrict your funds. Need to assess your overall financial plan rather than be so determined to play in RE, IMO. RE is not without risks. Which is another reason to fall back and have your RE business feed itself, there is a difference in a loss created from money generated out of an investment than a loss suffered from cash earned and set aside. :)

Daniel Dietz · Answer

All of my stocks and mutual funds are tied up in IRAs and ROTH IRAs. I made the 'mistake' of socking away every dollar I could for years. I'm glad I did it to build a nice nest egg, but wish I had some more assets that were available to use. The Insurance and Primary Home equity are really the only assets I see as useable (my understanding, at least from the banker I am working with, is that retirement assets cant be assigned). Dan Dietz

Daniel Dietz · Answer

Bump............