HELOC vs Cash out Refi? And when is the right time to cash out?

Question

We own 3 identical homes on the same block, purchased 3/2015, 12/2015, and 10/2016. The first was a short sale, and was purchased as a place for our daughter to live in while going to college. She pays rent that is basically B/E.

The prices on homes just like these in the neighborhood has gone insane in the past couple months, and they are selling in less than a day. I'd like to take some cash out of these homes to use to purchase more property, but have two questions.

First, should I wait until the property values have increased enough that I could take out my entire initial investment before doing the cash out? This would eliminate the last house, and probably the second one because of the improvements we put into it, although it would be close. This seems to me to be the most sensible thing, though, considering the cost of doing the refi. I would only want to go to 75% LTV.

Second, we have the most equity in the first house, well over our initial investment. However, if I refi, I will be in a negative cash flow situation because my daughter can't afford to increase her rent while she's still in school. I'm interested in using the cash to help purchase BRRRR properties, which if done properly would return my initial investment, which I could use to pay off the HELOC, but I would be locked in perpetuity (albeit at a lower rate) if I refi. So which is the best approach? Can you even get a HELOC on an investment property?

I'm kind of answering my own questions, but I'd appreciate your input.

Andrew Postell · Answer

@Katherine S. since you are looking to buy and hold these properties I would suggest as long as a fixed rate as you could find. That would probably mean doing a traditional cash out refinance. Lines of Credit are good options but with the variable rates that they all have you might be in a pretty tough interest rate in a few years. Lines of Credit usually have a 10 year limit. Meaning if you still have a balance after 10 years it turns into a mortgage at a SIGNIFICANTLY higher rate. If you were looking to flip, then you pay back the LOC each time and the variable rate isn't so important.

Now you mentioned that in on one home you would be at a negative cash flow position because your daughter rents this home. You could certainly not do a cash out loan on this property but the idea here is that on the next property you do buy it would be a positive cash flow. Remember we are doing this to buy more properties that cash flow. If you traded a $100 to get $300, would you do it? Of course you would. That's the idea so keep that in mind.

As far as waiting goes it can be difficult to predict the future. Maybe the houses do increase in value...but what if rates are higher? There are so many variables you can almost paralyze decision making when trying to predict the future. If you have a purpose for the money now, then take advantage of the numbers you know and pull the trigger if there is a use for the money now. Hope this helps!

Andrew Postell · Answer

@Katherine S. Oh, that is a much better explanation. Ok, I certainly know what to explain to you from your description. I'll work backwards on the transaction. So if you have a fully renovated investment property you will be limited to receiving 75% cash out after 6 months ( 75% LTV). This is working on the assumption that you are using your HELOC to use towards the downpayment and you are using the loan to purchase and renovate the home. So if you bought a home for $50k, put $20k into rehab, and the property was worth $100k, then you could do a cash back refinance for $75k after 6 months. So essentially you would get $0 back...since you would have to pay closing costs again to refinance. Your purchase price and rehab costs would have be be pretty good to give you more cash. And I would almost advocate that if you have that much equity in a rehabbed property...maybe selling might be a better move. That would be $30k in profit if you sell (well maybe $25k with realtor/lising fees). But then you can buy 2 more rentals with the profits.

Now that 75% LTV rule is a conventional rule. You might be able to find a portfolio loan that can give you 80% but you will either pay a higher interest rate, or the interest rate will be adjustable, or the mortgage will be on a shorter term (like 15 years) which makes your monthly payment higher...and sometimes it's all three.

I hope this wasn't too much information. But if you have more questions then ask away. This is a very common area of discussion on BP and further questions you have will help others when they see this post. Thanks!

Now that 75% LTV rule is a conventional rule. You might be able to find a portfolio loan that can give you 80% but you will either pay a higher interest rate, or the interest rate will be adjustable, or the mortgage will be on a shorter term (like 15 years) which makes your monthly payment higher...and sometimes it's all three.

I hope this wasn't too much information. But if you have more questions then ask away. This is a very common area of discussion on BP and further questions you have will help others when they see this post. Thanks!

Steven Young · Answer

@Andrew Postell You clearly know your stuff in this realm! I am trying to understand when a HELOC is more advantageous than a cash-out refi and vice-versa.

So I bought this duplex a 3 months ago and am currently living in one unit (house hacking) while doing some renovations. My plan is to live in it for a full year and then buying another multi-family to house hack and repeating the process from there. I bought the property for 95k and put down 5%, so my current balance is 90k. The property appraised for 120k during the loan process, and with some renovations and increase in rents I think it would appraise for around 130k. I was locked in at 5.125% interest rate but interest rates have already dropped significantly in the past few months. My thinking is that I could wait a little longer and finish repairs, refinance at the lower rate and in the meantime pull out around 30K (a local lender told me that because it is my primary residence I can refi up to 95% ltv which is where I started 3 months ago anyways). Between the lower interest rate and the fact that I want to use the proceeds as a down payment on my next property, I was thinking that the cash-out made more sense. Also, it sounds like a good opportunity since I can refi up to 95% whereas it seems from what I've read that if it was not my primary residence I could only pull out up 50 85% or so. I want to make sure I'm seeing the whole picture before moving forward though, what would be some advantages of the HELOC?

Roy N. · Answer

Katherine:

You have the correct approach ... it's a math problem. If the return you can earn by re-financing and investing the capital into another property exceeds the costs of refinancing by a sufficient margin, then it makes sense to go that route.

Roy N. · Answer

@Katherine S.

The general practice we follow with residential properties is "if we have an {almost} immediate use for all the equity that we can/would withdraw from a property, we will refinance and place a mortgage to obtain a more favourable interest rate" ... here, that means locking-in for a maximum of 5-yrs (no one takes a 10yr term) ... for you it frequently means locking-in for the amortization of the mortgage.

If we do not have an immediate need for all / most of the funds, but want access to them, we will endeavour to place a secured line of credit (LoC) on the property - though it has become very difficult (if not impossible) to obtain an LoC on a residential investment property here in Canada. A third alternative is to go the route of a second mortgage, but that is generally not a cost-effective preference.

Andrew Postell · Answer

@Steven Young thanks for your patience here as I got back to you. Since I am not licensed in Arkansas I just want to speak to only the pros and cons to a HELOC if that is ok. Meaning, I cannot comment on rates and Loan to Value percentages.

Two of the common areas of concern for HELOCs I see out there is the 10 year maturity date and the adjustable rate. Since HELOCs have adjustable rates they will often catch people off guard when they adjust. With rates moving higher, it is likely that your rate will increase in the future. The 10 year maturity date is where the HELOC will modify into a different product all together. Meaning after opening the HELOC for 10 years it will cease to be a HELOC. It will "mature" into a 20 year fixed rate mortgage that you can no longer draw on. And when is matures the rate will increase. I've seen typical numbers of 1%-2% higher than your current rate.

But the advantages to HELOCs are the closing costs are SIGNIFICANTLY lower. I have even seen $0 closing costs before. And you are not paying interest unless you use it. So that's an advantage too. Everything has it's pros and cons I guess but if you have a plan to pay it back....that's the ideal product for investors. That's why flippers love them. Just make sure you have an adequate plan of paying it back as soon as possible. Hope this helps!

Katherine S. · Answer

@Andrew Postell I think I was a bit unclear about my purpose for using the equity. I'd like to increase my portfolio by buying fixer uppers at a discount, perhaps with cash, doing some rehab, renting and then refying those properties to pull the initial equity out. That could repay the HELOC, or could be used for the next purchase. I'm not looking to have HELOC loans out for more than a year or two at most, but I could be taking out one, repaying it, and then taking another. Rinse and repeat.

Going with a HELOC, I'd be funding my next purchase with OPM, without reducing the cash flow on the original property. If I do the cash out refi, I'd be using my money, and I'd be permanently reducing the cash flow on the original property.

The more I think about this, the more I am leaning toward a HELOC, unless I am missing something in this equation?

Katherine S. · Answer

@Roy N. Thanks Roy. I currently have 30 year fixed mortgages on all three. Shorter term or amortization would negatively affect my cash flow, and a refi would probably be at a slightly higher interest rate than I have now.

HELOC vs Cash out Refi? And when is the right time to cash out?

HELOC vs Cash out Refi? And when is the right time to cash out?

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