HELOC: to repay or not to repay?

Question

Late in 2021 I used a HELOC as the down-payment on a duplex in Michigan.  The duplex was turnkey, but has the potential to add a couple bedrooms in the future.  Currently it is fully rented so will probably add rooms at the next turnover.  My question is: should I be working to repay the HELOC or should I wait? The HELOC has a 10 year interest-only draw period (currently in year 2) after 10 years the loan locks an interest rate and is amortized over 15 years with no further draws.  The rate is variable, and is currently at 4.5%.  The monthly payment on the $40k that I've borrowed is $125/mo.  I have about $10k of cash reserves that I keep for all 3 of my properties for vacancy, Capex, and repairs.  The property cash flows even after the HELOC payment so I've been paying $500/mo to knock out the principal but because its a lower rate than I could refinance at today im not likely to do that. Should I be putting that 8k against the HELOC? The HELOC is completely liquid, I can just borrow it back out if I needed a repair or even a vacancy.  For some reason the cash in the account feels safer than the HELOC debit card. Should I even be paying the extra principal ever month?  Am I thinking about this wrong?  Appreciate any and all advice!

Alex Breshears · Answer

Hi Travis!

This is a great question and really involves what your long term goals are. For example, HELOC's are usually calculated as simple interest, versus amortized interest, which is what will happen at the 10 year point.  The reason I bring this up is because you left out some crucial details about the "big picture" that would influence my answer.

Let me give you a scenario:  You are looking to create some passive income without a lot of time commitments.  There are a ton of ways that can be done. But say you want to own residential rental units to get that done. Here is where the fork in the road happens.  If you want to have just a few properties paid off, thus really increasing your cash flow, then I would say start paying down those amortized loans first. Look at your statement sometime and you will see exactly how much of that payment is going towards the principal balance. Depending on what the rates are and the goals you have in mind, I would direct it at the loan that either has the lowest amount (so fastest to pay off) or if there is a large discrepancy in rate, pay down the higher rate one.  Then once you have one paid off you start working on the next one.  This would allow you to have a few doors completely free and clear of leverage and really make some serious cash flow.  Remember more houses is not always the answer. That's more overhead, more needed in reserves, more tenants to deal with, more maintenance needed. Depending on the type of deals you buy, having 3 paid off could be more cashflow each month than 15 with mortgages.

But if you are at a point where you are investing largely for appreciation, it makes sense to take on leverage to get more properties so you can ride that appreciation wave. Leverage responsibly though.  Do not set up a house of cards, where you continually borrower from one to get the next using HELOC's for example. That sets up a situation where even one or two months of missed payments by renters really puts the whole portfolio in jeopardy because you are "robbing Peter to pay Paul" type of situation. I fully get doing it on your primary residence when you are starting out, but after that point the most I personally would do is a cash out refi (as long as it kept the property with a decent cash flow) to use for the next one.

I hope that helps!

Travis Barkel · Answer

@Alex Breshears incredibly thoughtful advise.  I am a big fan of the small but mighty portfolio as I do have a W2 and a young family that keeps me quite busy.  I would like to expand but in a limited way in the next two years.  As long as I'm getting the kind of deals that can cover the HELOC I feel like it's a decent strategy to continue to grow.  I guess for now I'll keep my course and consider the extra money against the HELOC as future capital I can deploy into my next deal.  Thank you, thank you, thank you for the help thinking about this from additional angles.