Best way to get the equity out

[Soh Tanaka]

I'm considering using equity in my house to purchase a rental property. I can get a home equity line of credit, 2nd mortgage or do cash-out refinancing. What would be the best option? 

[Joseph Zanazan]

I think the answer to your question lies in the details of your personal situation. For example, average borrowers' who are trying to pay off credit card debt , 9 out of 10 times will opt for a HELOC first and then years later end up doing a cash out consolidation loan to combine their first with the 2nd (HELOC). Investors would potentially be a little more strategic and well-orchestrated with their moves.

As previously mentioned, a HELOC will be predominantly adjustable. Some investors feel comfortable with their rate tied into an adjustable index because they understand their current market conditions. They understand that as long as the Chinese economy continues to suffer and the price of a barrel of oil stays at record lows due to a high supply and low demand, that more often than not interest rates tied into indexes like the CPI will reasonably keep short term rates low for a while. They're aware of their timelines and how long they will have to carry this debt and will tackle projects accordingly. These projects typically have a turnaround of a year, give or take a few months. They will leverage the low maintenance accessibility to their advantage by getting in and out of the loan before the circumstances become less than favorable. This typically works in "flip" type situations where you earn a return on your investment along with the money you've invested fairly quickly without carrying extra risk. In this situation, ease and cost free accessibility will favor an equity line any day of the week. Short term rates, as in the rates tied into indexes that are the most sensitive to economic shift will move before the 30yr fixed loan rates would. For an informed borrower, there should be enough time to make a move on a cash out consolidation loan. Typically, when indicators like the yield on our 10 year Treasury bill starts to rise, it's time to fix your rate.

You however mentioned that you're looking to use this money as a down payment for an investment property. This suggest that your strategy is a long term or buy and hold strategy. In this situation credit score can play a huge role. Depending on strong your fico score is and the loan amount, a loan level pricing adjustment like CASH OUT will typically have an adjustment of an eighth to a quarter percent. As mentioned, depending on your loan amount, this difference in rate can mean only a few extra bucks on the payment at the end of the month. Some investors would consider this a more conservative approach to their investment simply because they don't intend on paying the loan off organically anytime soon. Instead of rolling the dice on a possible cash out consolidation loan down the line that might be necessary due to the borrower's inability to pay off the HELOC organically, a cash out loan today would guarantee that the net cost of money is no more than only an eighth or quarter percent. By agreeing to pay an extra couple bucks of interest today, you would eliminate the possible scenario of interest rates going up years down the line at a time where you need to do the consolidation, aka the cash out refi loan the most.

The second mortgage, although typically a fixed product, will have an interest rate higher than the rate on your first trust deed. This would be purely a mathematical decision upon evaluating the proportions of the loans in respects to their potential interest rates. Cash out on one loan vs 1st and 2nd option. More often than not a HELOC will be more favorable in a flip situation vs a 2nd loan anyway due to the ease of accessibility so it’s really usually between the Cash Out one loan vs the HELOC option.

In order to be the best strategy, you would have to evaluate these situations individually. The philosophy behind it is fairly standard. If your credit is good and you're looking to buy a rental property, chances are a cash out loan today will be a better move. If your project requires a rehab and/or flip for example with the exit strategy sometime in the foreseeable future, a HELOC would perhaps be more convenient

The good news is that it’s a business decision at the end of the day and an answer to this question can be formulated in a pretty objective manner. Always keep in mind that the ratio of your first trust deed in respects to the new cash out amount. The real answer to your question would have to be on a case by case basis to truly be the most accurate. A lot of it is in the math folks, and how long you plan on carrying the debt. There is no right or wrong answer.