HELOC to traditional lending.. BRRR

[Jason Burnside]

I currently live in Greenville SC and looking to purchase another single-family property as a rental. I have a significant amount of equity in my primary residence and looking to leverage the equity through a HELOC. I still have a mortgage on the property but don't want to refi due to the existing low interest rate.

I am interested in using the HELOC to purchase the rental home and fund the capital improvements needed for the property. In theory, I would like to rent the property after the improvements are complete and get long-term financing after the fact and pay off the HELOC.

Below are a few questions I have relative to this plan:

- Is there any risk of securing long-term debt once the plan has been executed? 

- Overall, does this plan make sense or is there any way to leverage existing equity in my property for a rental property.

- Is there anything else in this equation I should consider before I go secure a HELOC?

[Andrew Postell]

@Jason Burnside thanks for the post. HELOC's are great products. If you have enough equity, there's almost no downside to having one - even if you never use it! Now, some people don't have enough equity...but after a while they will. The number to use for now is 80%. So take your house value and multiply it by .8 (essentially 80%). Once you have that figure then SUBTRACT out your current existing mortgage. Whatever you have left over, that's the amount you should be able to secure with a HELOC. Now, this math is for THIS example. You'll need to speak with a lender directly to know for sure. I bring up the math because some people think that they can get a HELOC no matter what...and that math above will give you a close proximity to how much of one you can get.

Now, you can get that HELOC without doing anything else. The cost to open one is almost zero and there's little downside to having one (more on that in a minute) but if you want to mitigate your risk of when you REFINANCE from a home you purchase then you will need to get PREQUALIFIED before you purchase your next home. Getting prequalified will tell you how much you can "afford", what your rate & payment will be, and what the Loan-to-Value will be on your future property. That last one is really important when trying to pay your HELOC back (which I strongly recommend...but more on that in a second). So to answer your questions:

- Is there any risk of securing long-term debt once the plan has been executed? - Yes, there is always risks.  Getting prequalified will help mitigate some of those risks...but we are talking about investing and there's always risks in that. 

- Overall, does this plan make sense or is there any way to leverage existing equity in my property for a rental property. - Makes lots of sense and many people do this same technique with great success.

- Is there anything else in this equation I should consider before I go secure a HELOC? - yes, and that is below...

To me there's a couple of main points of difference between the two:

1. Lines of Credit have low costs but the rate adjusts

2. Mortgages are fixed Rates but have higher costs

What this means is that a HELOC is NOT designed to be a permanent financing solution. Two of the common areas of concern for HELOCs I see out there is the 10 year maturity date and the adjustable rate. Since HELOCs have adjustable rates they will often catch people off guard when they adjust. Rates are higher now...but what will they be in 5 years?, Who knows? That's called risk. Unknown = risk. The 10 year maturity date is where the HELOC will modify into a different product all together. Meaning after opening the HELOC, 10 years later it will cease to be a HELOC. It will "mature" into a 20 year fixed rate mortgage that you can no longer draw on. And when it matures the rate will increase. I've seen typical numbers of 1%-2% higher than your current rate.

What HELOCs are designed for is to be a giant credit card. To open a credit card is really cheap and so is opening a HELOC. They make is easy to get so it's easy to use; and just like any credit card, you need a plan to pay it back. So, if you use it to say....buy another property, then refinance that property...thus paying back your HELOC. Then that's perfect! Because you will never get surprised by an adjusting rate or keeping a balance on it. HELOCs are PERFECT for people who have a plan to pay it back.

On the other hand, if you were going to use the entire HELOC to purchase a property that you were looking to buy and hold for 30 years....this would be very counterproductive. The 30 year fixed rate loan would be a better fit for this purpose.

You might be able to think of some other scenarios but hopefully this concept is good enough to know the difference between the two. 

Hope all of that makes sense.  Thanks!