Using a HELOC/Home Equity Loan for down payment
Investor · Scottsdale, AZ · Member since 2021 · 11 posts · 11 votes
I am in the process of talking to banks about taking out a HELOC or Home Equity Loan on my residence which I plan to use for a down payment on a first rental property. I am having trouble wrapping my head around a couple of things:
1) When using as a down payment is one of these options better than the other (HELOC vs Home Equity Loan)? Or is it one of those things where both have pro's and con's and I just have to make sure the numbers work.
2) What I'm thinking is that I would use the money from the equity financing for the down payment and then eventually refinancing with a conventional loan to cash and pay off the draw I used towards the down payment so I can use it on another property. Is this a common strategy? What throws me off is that I see people in the forums that just keep the HELOC money in a property. With a variable APR and higher interest than a conventional loan it seems like you would want to pay that back as soon as you can right?
@Joseph Medina
Also be aware of fees. Cash out refinance is a new loan with all the fees that come with it. You are going to then turn around and take that equity to purchase a rental (using the equity as a downpayment) and have another round of loan fees. Double whammy.
I prefer a HELOC, because it gives you flexibility and is a fraction of the fees. I've never purchased something that didn't have a repair needed a couple months in and having a HELOC is nice for those small unforeseen expenses. And you only pay interest on the portion of the HELOC you currently use.
Be aware of your debt utilization, making sure you aren't maxing out the HELOC because it will affect your credit score if your overall credit utilization is high but the flip side of that is taking out a larger then needed HELOC will impact your DTI as lenders will calculate your DTI with the assumption you've maxed out your HELOC. My opinion though is the second option is better.
The "HELOC to purchase a rental" is how I started and it turns your primary house into an asset.
Blake,
A HELOC is the same as a home equity loan. The other option is a cash out refinance that offers a fixed rate with one loan and one payment. HELOCS aka Home Equity Line of Credit are usually based on a variable rates and right now most HELOCS come with a higher rate than a 30 Year fixed cash out refinance. HELOC's also can be a hard stop when it comes to banks/lenders using a open end liability as a down payment. They will have to calculate what the payment would be into the new loan for monthly expenses.
Some banks/lender require reserves and a HELOC cannot be used for reserves.
I'm a huge fan of HELOCS and use them exactly as you describe. I did recently refinance to get 80% on my primary to lock in the low rates but still have a 5% HELOC and plan on trying for more later as the property increases. A HELOC differs from a Home Equity Loan as you can recycle the money with a HELOC where a Home Equity Loan is just a second mortgage. I look at it as a low interest credit card backed by my house. I am still in accumulation mode so I'm not pulling any cash from the business so I pay down the HELOC as quick as I can with profits and then buy another property to start the process again. Another consideration is the heloc payment changes, assuming interest rates stay the same your payment goes down after each payment slightly but you can have increased payments when the interest goes up. For a Home Equity Loan you are locking in a low interest rate but your payment stays the same until paid off and any payoff is dead money unless you get a new one.
I want to follow this thread as this is what I want to do as well! @Jason Wray can you not to pull the cash out of the HELOC and place it into your personal account?
Because, you can pull the cash out of the HELOC and place it into your personal account and then set up a separate account for the house you want to buy, and transfer the cash into that account for the new house and then when you do that you can now write off the interest from the HELOC on taxes.
Either way I want to see how this thread plays out which is why I am commenting 🤣🤣🤣
Joseph,
Yes you can take out a HELOC and draw out the entire amount needed to put into a savings/checking account but it would have to be (4) months prior to the investment home purchase. Because the banks/lenders will ask for (2-3) months of bank statements and if they see a large deposit they will require it to be "sourced" which will then lead back to the HELOC. Some banks and lenders are okay with money out of a HELOC for the DP but not for the PITI reserves required which is typically (3-6 months) but that goes off of loan size.
But my question would be why would you want to take out a HELOC if you can do a cash out refinance. You have one loan, a fixed 30 year rate and cash on hand (liquid reserves)? A HELOC in most cases carries a adjustable rate compared to 30 year rates are lower now especially after FHFA lowered it's .50bps hit. COVID was a bit of a surprise right? If you could have had a 30 year loan with a fixed rate or a HELOC with a higher variable rate during a time like COVID which one would most people want during unforeseen times, especially with renters not being able to pay...
If you have no mortgage and your only taking out $10K-$30K and have a small project than Yes I would say take out a HELOC. But in most cases that cash in hand and one loan, one payment based off of a 30 year fixed rate seems more attractive. You can deduct HELOC interest from your passive income earnings. But if you have a rental property you can do the same thing on your schedule E if you do a cash out refinance. The tax benefit is really based on the individuals income situation.
I read another post above where a BP member like HELOCS and uses it as a credit card type loan. That is completely fine but in my 20 years I cannot tell you how many investors come to me to pay off a HELOC because there is another project coming due. You can only have (1) HELOC on a home. If you do not have it paid off in time you have to do a cash out refinance to consolidate it and take out cash.
If you did a cash out refinance you would only have (1) loan under that scenario and could borrower money either way. If you have a $30K HELOC and have used $25K you only have $5K left you cannot borrow more money your stuck. Again Pro's and Con's but I have seen way more people refinance and consolidate a HELOC and in most cases take out more cash.
@Jason Wray, I guess the reason would be if I didn’t get as good of a rate as the current rate I am financed at, but after reading your post I think I will look into the cash-out refi as an option then 😎😎😎 thanks a million!
@Joseph Medina
Also be aware of fees. Cash out refinance is a new loan with all the fees that come with it. You are going to then turn around and take that equity to purchase a rental (using the equity as a downpayment) and have another round of loan fees. Double whammy.
I prefer a HELOC, because it gives you flexibility and is a fraction of the fees. I've never purchased something that didn't have a repair needed a couple months in and having a HELOC is nice for those small unforeseen expenses. And you only pay interest on the portion of the HELOC you currently use.
Be aware of your debt utilization, making sure you aren't maxing out the HELOC because it will affect your credit score if your overall credit utilization is high but the flip side of that is taking out a larger then needed HELOC will impact your DTI as lenders will calculate your DTI with the assumption you've maxed out your HELOC. My opinion though is the second option is better.
The "HELOC to purchase a rental" is how I started and it turns your primary house into an asset.
@Jason Wray and @Andrew Kougl, MAN THIS IS GREAT!! you two are providing two sides of the coin that I needed to see. I mean I guess the route I would take is that if the property is more of a BRRRR maybe a cash out refi or HEL would do the trick just make sure there is enough cash to be able to finance the hole project and if it's a turn key property maybe use a HELOC as the down payment! Man I hope people add more to this thread
Not to hijack this thread but this was perfectly timed as I've been on the racetrack for methods to raise capital for my 2nd property. So, thank you for all the great info here. If I could add a little something- my personal residence is with a 0% down VA Loan, only 14months into mortgage so far. For HELOC, it seems you need atleast 20% equity correct? We've added value a whole lot already with some remodels(kitchen,bath, flooring, landscaping) Edit: however, have not done a refinance.
My 1st rental, I did Conventional Loan with 20% down at the beginning of the year. Is it considered more risky to open a HELOC within a rental?
I am loving reading all the responses, this is exactly the type of discussion I was hoping for when raising these questions in the first place.
To be more clear as to what I'm trying to do: I lack enough cash to put 20%+ on a down payment on an investment property, especially in the current flaming hot market of Phoenix. But, I do have some equity in my primary residence that I can/want to put to work. So in the spirit of the old "HOW can I afford it" model I am exploring these options to make my goal of buying my first investment property by the end of the year.
@Jason Wray I am also looking into a cash out refi. I guess the reason I have been leaning more towards HELOC is that from my research it seems like I may be able to get access to more from the equity in my current house from a HELOC vs cash out refi. Some banks I've talked to do up to 85%-90% LTV, where cash outs seem to max out at 80% LTV.
A heloc downpayment, is a borrowed money downpayment.
This is how i purchased my 2nd property with "0%" down from actual money in my bank, but "20%" down from the heloc.
Go to your bank, get your property appraised, get the heloc.
Once your ready to buy your next property, the heloc is there and ready to be pulled.
Keep in mind, for every thousand you have available in heloc, thats a thousand less availabile to you on your mortgage. Because the bank sees that heloc as an active loan, regardless if your using it or not.
@Blake Wilson
I do not know what the “answer” is per se but we did a home equity loan on a rental and used it for a down payment (25%) on a rental. The time between transactions was about two months.
Why not a cash out the finance? Could not beat our current rate.
Why not a HELOC? Needed the money one time, not revolving, so opted for a loan with a set interest rate.
The monthly payment on the loan effects debt to income ratio so need to make sure you have room there.
Don’t over leverage!
@Kimberly Carver
**cash out refinance
Lots of great info and perspectives here, thanks!
@Johnathon Courtot, hey bud you might be able to refi out of the VA loan, so you can use it again. I am not sure if you need to live in the property, but if you do you can do the ‘"move-in flip" or "move-in rent" model, if not boom you have a rental you can utilize! 😎😎😎 this thread has been awesome!