BIG HELOC Energy: Why large equity lines can be hard to get and what to do instead

[AJ Wong]

With many seasoned real estate investors locked into low first mortgage rates and large equity positions, many borrowers and investors have been exploring tapping second position loans like home equity lines of credit for reinvestment capital towards down payment or rehabilitation funds. 

We work very closely with a national lender and strategic mortgage partner with a diverse second lien position and second mortgage investor product offering. The challenge that many borrowers run into when looking for larger equity lines with limits of $250k+ is that they typically require full income verification (not always bank statement and DSCR exist) with lower DTI ratios (43-50%) however although the repayment scheduled is based off a simple interest only payment, (usually a 30 year amortization schedule with the initial draw period of 5-10 years) the qualifying rate is based off of the converted twenty year amortization schedule (240 equal installments) of the payback period. At present, a fully drawn $250K HELOC with (optimal credit) would offer an indexed rate based off of Fed Funds or Prime + 3-4% rate (depending on LTV, Property Type, Credit and LA) currently pricing at between 8.5-11% (11.5-13% w/lower credit) and interest only payments of +/- $2000 but the qualifying rate and payment for underwriting would be nearer $2300+ (on the low end) plus the 1st mortgage, and accurate taxes and insurance.

This is particularly restrictive when attempting to qualify for larger balance home equity lines of credit of $350-400-500K. 

We've found the majority of large balance HELOC's or fixed second position mortgages are intended for acquisition or reinvestment towards property that might require new or replacement financing. In other words, sufficient capital for the cash purchase of a property (plus rehab) and eventually refinancing the completed project to a long term loan. Or primarily for sufficient capital for down payment and obtaining a new DSCR or alternative qualifying loan for the target acquisition.

Although there are alternative income qualification methods for fixed second loans and HELOC's utilizing bank statements and even DSCR rental income, as the lender risk increases, generally so does the borrower's interest rate. Double digit loans of $250-500k can be both cost and qualifying prohibitive. One solution for investment property HELOC's would be to consider a first position DSCR cash out refinance.

Generally the maximum cash out limits on cash in hand can be higher (above $500K for most HELOC's) and qualifying is much less cumbersome. The loan is qualified based on the actual or market rents of the property determined by a lease or appraisal. The downside is that borrowers would be required to pay the mortgage on the full cash out amount from loan inception, the benefit would be that the actual interest rate could be closer to the 7%'s than the 10-11-12%'s (also with an interest only repayment option) and the need for a new mortgage (second loan on the target acquisition) could be eliminated if the equity position on the refinance is large enough. Notably it is common for investors with sufficient equity for a $250-500k HELOC to have low or no first lien balances on the subject property.

Furthermore on the target purchase, investors could theoretically have more buyer leverage as a 'cash' transaction and eliminate associated mortgage closing costs and have more investment options as a 'cash buyer.'

Obviously paying interest on underutilized capital is sub-optimal but when factoring in the cumulative proposed transactional savings, the annual total interest cost could be equivalent or lower than the net of an alternative home equity line of credit on the same principal loan amount.

One 'hack' could be to delay the actual closing of the DSCR loan until a quality purchase prospect is identified and/or near under contract. If well coordinated, at a minimum that provides 30-90 days without being responsible for the mortgage payment.

Investors exploring this strategy will want to emphasize efficiency and be sensitive to PPP (Pre Payment Penalties.) Many DSCR loans come with standard 2-3-5 year Pre Payment Penalties, borrowers usually have the option to 'buy out' of these penalties upfront with points or by accepting a higher interest rate. Many borrowers that elect to utilize a first lien position mortgage as opposed to a HELOC try to reduce the pre payment penalty (to one of none) so that they can pay down the loan balance from the proceeds of their completed acquisition and refinance at a lower loan amount.

Another alternative to DSCR cash out refinances could be fixed rate second lien position loans which can offer expanded guidelines and slightly more attractive loan rates.

[Joseph Chiofalo]

Hi AJ,

Equity lines can be helpful in the right situations.  

The challenge, like you mentioned, is to qualify - the heloc is underwritten on a 20 year amortization.  

Most lenders will restrict up to 50% debt to income ratio max.  In some instances lenders may allow exceptions a bit above that with compensating factors.