Debt free other than mortgage....HELOC for investing?

Question

We're purchasing our first rental at the beginning of 2020. I'm funding that through cashing out some stocks and using some savings with a 30 yr mortgage. Hoping things go well and looking to purchase another prior to the end of the year. I have enough that I could do the 2nd property down payment without issue, but if I'm looking at a third property soon thereafter I'd need to find another means of doing a down payment. We have about 110k equity in our house valued at 420k. I'm not worried about paying off my primary residence mortgage as my wife and I both have secure jobs. Any advice on using HELOCs for future purchases and then using cash flow to pay down the HELOC? Do you consider this risky?I just don't want to overextend myself. I think a property a year is reasonable. That said, with cash flow from two properties (and then three, I think I could come pretty close to being able to purchase a new property at least every 18 months between cash flow and additional savings, basically paying off the HELOC each time and repeating the process.

I appreciate your input as I'm new to this but am seeing my plan develop and move towards reality. Thanks

Thomas Rutkowski · Answer

@Mark S.

The only other question, then, is how quickly (or slowly) to pay off the HELOC based upon these numbers. In my opinion, that's largely a function of property cash flows (assuming using those to pay it back), the interest rate environment (rising/falling), etc.

If you can get money at 4% and invest it at 5%, how much would you want? All of it, right? Conversely, why give the bank its money back as long as you can make productive use of it?

Mark S. · Answer

I see.  I don’t think I’ll have that problem for a long time, if ever.  I have a relatively high paying W-2, several rentals (where they use $0 of the rental income on my mortgage application), and no consumer debt.  My only debt are mortgages.  If my DTI ever gets tight or I have a job loss/downgrade, I imagine they’ll use a percentage of my rental income (and I should still hopefully qualify).

Renee Lee · Answer

@Mark S.

Here’s the issue I’ve run into with the HELOC, my credit is very good. But my DTI will not allow me to purchase additional property.

Fred Cannon · Answer

@Martin Silverstrim. I am from an older generation and have seen a couple of bubbles burst.  The thought of risking my primary resident to an investment would require rewiring my brain.  Even though you think you are doing great in the money department and can handle the risk I would do some more analyzing to be sure.  I am a firm believer in no risk no gain but all risk and living in the street if it goes south is what happens if you loose your house.  Also consider what is your goal, what is your timeline.  My goal was to own 10 properties at retirement.  I am not  willing to give up my job with great benefits to be a full time landlord with no benefits and I  don’t want to manage more than 10 properties in retirement.  So for me life is about being stress free and having a comfort level not about owning 100 or more doors or apartment buildings etc.   To each their own   I get 10k COC a month in rent, my doors are paid for, and I live the life  of a person that is truly blessed   It took me 70 years to get here but I still got a few years left.

Mark S. · Answer

@Martin Silverstrim, I’m considering doing the same.  I’ve talked to my lender multiple times about whether or not it’d be okay to use a HELOC on my primary as down payment on a rental.  They’ve repeatedly told me it is, however, I’ve not done it yet (but am planning to for an SFR I’m going to close on in the next 1.5 months).

My tax team has advised me that as long as I can trace the funds from the HELOC into the new investment property, that the interest paid on the HELOC is deductible.

My current HELOC (variable rate at Prime minus 0.51%) interest rate is 4.49% (currently less than what my 30-year fixed interest mortgage rate will be!).  Yes, there is a risk to this variable rate, but I don’t see this being a major issue any time soon; and if it is, I have a couple ways to handle it: 1.) lock feature on my HELOC that allows you to take an outstanding balance on a variable rate and “lock it in” to a fixed rate at .5 - 1.00% higher and amortize it and 2.) I have cash I can use to pay it off, if needed.

It’s still a relatively foreign concept to me, but I’m trying to get used to the idea of responsible leverage.  I know there are other ways to do similar things (cash value life insurance, infinite banking, etc. - which I’m still learning about), but for the cash vs HELOC thing, the way I see it, looks like this:

Let’s say I have $30K set aside for down payment and closing costs in cash in a high yield savings account earning 1.70% (interest earned being taxable at ordinary income tax rate). For simplicity, let’s say my effective tax rate is 20%.

Now, let’s say I also have this HELOC that I can tap for the $30K at 4.49% (and the interest paid is deductible). Let’s also assume 20% effective tax rate.

What’s the NET cost, and benefits of, using the HELOC?

$30K at 4.49% deductible is really $30K borrowed at 3.59%.

$30K savings at 1.70% taxable is really $30K saved at 1.36%.

My effective TRUE cost of borrowing, the way I see it, is 2.23%.  AND, I have the benefit of having the LIQUIDITY of that $30K in savings.

To me, this seems like a no brainer.  I understand in your case, you may not necessarily have the same amount in savings already and that’s the whole purpose of you using the HELOC, so in your case only half the above equation applies, but either way, isn’t that a fantastic cost of capital that is likely being leveraged into an income producing asset with a much higher rate of return?!

Maybe I’m missing something - and if so, someone please chime in.  But it’s for the above reasons I’m strongly considering using my HELOC on this next purchase versus my own cash.  I understand the underlying risk of my primary residence as collateral, but I have plenty of places I can go for cash if things really went sideways, so I’m not overly concerned about it.

The only other question, then, is how quickly (or slowly) to pay off the HELOC based upon these numbers.  In my opinion, that’s largely a function of property cash flows (assuming using those to pay it back), the interest rate environment (rising/falling), etc.

I’d love to hear others’ thoughts on this in the BP community.  Sorry for the long winded post, but I think this can be a great and extremely informative discussion for all.

Martin Silverstrim · Answer

@Will Fraser

Thanks hadn't thought of the lender having an issue with it, but I'll look into that end. Yes, I like the idea of rinse and repeat. I'm realizing more and more that I don't need to build up from zero every time once I get rolling.

Will Fraser · Answer

HI @Martin Silverstrim!  I've thought about this same thing and I've kicked around some ways to apply the Velocity Banking concepts to real estate investing.  I think that if you used a HELOC to purchase a new property and then used the cashflow from that property (and the others perhaps) to pay down that HELOC aggressively, once it is paid down you have a rinse-and-repeat source of funds for a new purchase.

The caveat here is that your funding plan with your lender will need to be A-OK with you using the HELOC as a source of down payment on a purchase.  This wouldn't likely be an issue with any investment type of loan, but since it is technically a hybrid of equity and debt a mortgage lender might have an issue with it.

Best of luck and preparedness on the journey!

Debt free other than mortgage....HELOC for investing?

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