HELOC vs. Cash out Refinance

[Nicholas Catanzariti]

Hi all,

I am looking to purchase my first rental property, but am debating on which route I should take to finance the property. I have been offered a 90% LTV HELOC at a fixed 2.99% APR for the first 6 months then moving to a variable 4.25% APR after that. My current mortgage is for ~ 275k and I believe the house will be valued somewhere in the range of 400-415k when appraised. I am not sure if I should do a CO REFI to avoid the potential of the variable rate increasing. I do not have a specific property targeted to invest in yet so I would benefit from the HELOC by not having to pay the interest while I continue my search.

Anyone have any thoughts? 

[Sean Grapevine]

How sure are you that you're going to use the funds? If you're sure you're going to use them, then the CO Refi makes more sense. If you're not sure, then the HELOC makes more sense.

[Nicholas Catanzariti]

Sean, I know I will use the funds at some point when I find the right property, but I have yet to do so.

[Sean Grapevine]

I'd say go with the CO Refi then. You could meet in the middle and get a 7 year ARM on the C/O and benefit from a teaser rate for longer. The HELOC's likely not going anywhere but up. And you won't benefit from the HELOC's lower rate if you wait to use the funds for some of the 6 month teaser.

If you're sure you're going to use the money, then you should just view the HELOC as an ARM with a very very short fixed rate period. Which doesn't sound, to me, like a great idea when compared to a full first mortgage.

[Max Gomeniouk]

HELOCs are cheaper from closing costs aspect. Once you use the funds, if the rate environment is favorable, you can always refi into a fixed mortgage and consume your HELOC. Few unknowns in this area however it will let you have access to funds at a lower cost initially. Just my 2 cents. Definitely run through a few scenarios with your lender.

[Shawn Q.]

I would avoid the variable rate myself. Also, 6 months seems short to me (I think my HELOC was 36 months at a teaser, then variable).

One other consideration - if you haven't identified a property the HELOC is a big risk in my eyes. That's because most HELOCs I've seen will require the collateral property be your primary residence. If you're just starting out it's hugely advantageous to buy each new property as owner-occupied and live there for a time. If your HELOC doesn't allow that, the bank can call it (which is rare, I think) or convert it to a property-secured personal loan or similar - and stop your ability to draw on the loan. This could keep you from accessing those funds needed for a live-in flip, or similar, just when you most need them. Also, depending on your specific loan the rate could skyrocket.

It's worth asking what those exits look like on a HELOC if you head in that direction.