Understanding how one rental is used as leverage??

Question

Just to get this topic rolling, the main thing I have heard a lot about, but not necessarily the most detailed info on is how my one house that in live in can be used as leverage assuming it is going to be a rental property as I move in to the next one?? I have heard so many different thoughts on this from people I know in real estate and it seems that it is a somewhat vague topic. Either that or they just might not have a total clue on what’s going on.

If I am going to turn a house in to a rental for example that has a mortgage of $720/month and can be rented for $1100/month, how can that be used or have an effect on qualifications for either buying another single family that is bigger or even leveraged to buy a bigger multi family property.

Brandon Sturgill · Answer

@Jesse E. it's equity...forced or otherwise. So, your goal is to have equity to leverage in the form of a line of credit...or in rare cases a re-finance and take out cash...things open a bit when you're free from your mortgage, but that may be a different discussion.

When you combine this with FHA for a 1-4 unit house hack, you can get into a property pretty cheap...typically just 3.5% down depending on your credit score and DTI.

House 1- simple example

$100,000 Appraised Value

$50,000 Lien (mortgage)

=$50,000 Equity

@95%LTV on a HELOC you could pull out 95% of $50k...or $47,500...

This is a second lien...so now you have 2 mortgages and more debt...but you have $47,500 to invest...you will have lending constraints on your 3rd mortgage (new property)...assuming you are using a conventional lender.

It's easy to get into trouble in a lot of these scenarios...people really just don't talk about it that much....you have to find value to make this work...buying at a discount with built in equity when you buy.

There are lots of iterations to this...just depends on your personal scenario

Axel Meierhoefer · Answer

@Jesse E. Dan and Brandon gave you some very good insights into the mechanics. There is another aspect to consider. As Dan said, you will have to decide if you move into the next property you buy or not. If you, for example, buy a triplex and move in one unit yourself, you would get the low down-payment advantage as it will become your primary residence. If you purchase an investment property in most cases you will have to put 20% down as long as you don't have 4 properties/units on the books or 25% for 5th or more. That's something to keep in mind.

The aspect of qualification you asked about is what I call "The Dance". It's a very long story with many facets but for your scenario what you will potentially run into when it comes to qualifying is the issue of 'proof of income'.

When you decide that you keep your current property as a rental (even if it is cash flow positive) and buy a new property, the underwriter will/might say: "Prove to me that you actually had the $1100/month for at least 1 year or show me where it is listed in your tax return". There are some ways around it but when you are still relatively new to real estate investing it is often hard. I lived through it the first three times until I got my portfolio to a point that it is no longer an issue (now I have now ones to deal with :) )

I am not saying it will for sure happen, but be prepared that when trying to qualify for your next purchase, you might be asked how you afford to pay for both mortgages. (current property + new one). You might say: " I get the rent from my current property as soon as I am out and I pay the new property from my income - but they potentially will not accept that.

If you like to discuss further I am happy to be available. Just wanted you to be aware of that possibility regarding your ability to qualify for loans, regardless if it is HELOC or FHA, conventional, etc.

Axel Meierhoefer · Answer

@Jesse E. You are right. One other thing to consider. You can establish the HELOC right now while the equity in your property is high. As long as you don't use the money you basically have no payments on it.

I suspect there will be a significant correction in prices in 2019. That would allow you to be more flexible to jump on a good deal and you would not have to ask for a HELOC at a lower valuation of your current property.

There are a few things to consider about possible lender adjustments, but normally they worry about all other issues and you would get the cake and eat it too following that approach.

I am doing that with one of my properties right now.

Jesse E. · Answer

These are all extremely helpful for sure! As noted there, I am slightly unsure if I want to buy an investment property and stay where I am at or buy a new residence and rent out my current home. I realize this can definitely be a tricky thing to get financing for. Especially as I am self employed with a floor refinishing business, so my income changes year to year as well.

I guess I will have to take advantage of what’s on here as far as tools and just figure out what it is that seems to make the most sense for me and my financial situation. It’s hard to know which option is best unless you have a set end game plan which I realize. I am pretty sure I don’t want to pull out all of the equity I have to invest, but then again if the deal was right, maybe I’d have to just take the plunge.

I appreciate all of your insight thus far!!

Axel Meierhoefer · Answer

@Jesse E. One more thing to Dan's description. I highly recommend using the Bigger POckets investment property calculators. You can run all kinds of scenarios to see what your cash flow and stuff will be and when you have the one you want to use you will have a super detailed report (PDF) to take to the lender

Dan Maciejewski · Answer

As @Brandon Sturgill said -- you'll be using the equity in your primary.  The equity is the difference between what it's currently worth and what you owe.  He explains that pretty well.  I would just make sure in that scenario that you can and will rent your 1st house out at a rate that will cash flow the new lien.

So, in that example, if you pull $50,000 out, you now have the $50k from your 1st lien and the $50k from your new HELOC equals $100,000 of debt service which is around $550/month Payment and Interest  plus your Taxes and Insurance.  I have no clue what those are in your area, so I'll just estimate another $200/month.  That's a total of, say,  $750/month PITI/debt service, so you'll be making sure that your rents are above that.  It looks like you're close to those numbers with your scenario, although Mortgage balance and equity numbers may be off a bit.

So you're starting to see $350/month to the good and now you have to account for the fact that your insurance and taxes are going to change (usually insurance down and taxes up) and you want to keep aside Repair/Maintenance, CapEx and Vacancy reserves, whatever those look like to you.  Then you'll see whether you look positive or negative for the year and decide if using that property as a rental makes sense as an investment!  If it doesn't, you can run the numbers on selling the property to use the equity that way, as well.

Then you would take the HELOC and/or saved cash and use it as a down payment on your next property.  Either 3.5-5% down on 1-4 Unit or 20-25% on a 5+ Unit.

It sounds like you haven't decided whether you want to upgrade your personal residence or buy a dedicated investment property -- that's another consideration, too!

Good Luck and I hope we explained a little bit.  Call some trusted and well-regarded local lenders to run the numbers, too!

Understanding how one rental is used as leverage??

Most Popular Reply