Using HELOC to fund deals ?

Question

We are planning to build our personal home in the next couple of years. In the design phase, I’m intentionally wanting to add features and value to later use as part of my long term funding strategy. We are a family of 5 so adding a couple of extra bedrooms, an extra bathroom per floor, a separate living space on second floor, extra garage space, brick/stone exterior, upgraded flooring and countertops, lots of closet space, etc. All will make our home more comfortable to live in but it will also add value that we can then use to fund future deals. Using the BRRRR method, we can Buy, Rehab and Rent it out without any need for outside funding or approval from anyone. Once rented, we can refinance with a traditional mortgage, pay off the HELOC and Repeat. Eventually completely paying off my personal home to where all I have is the HELOC available for more deals. Is this a good strategy to simplify the process of “finding” money for deals? Or are there hidden down sides I’ve not considered?

Jean H. · Answer

@Joseph Niedermeyer It sounds like you’re planning to end up with a first mortgage that’s fixed, and then a HELOC on top of that, and as you pay off your first mortgage, you’re expecting to be able to access that equity when you need to by taking it out of the HELOC. Your credit line for your HELOC does not go up as your first mortgage goes down. It is capped at the limit from when you got the HELOC. Since you’re getting the HELOC when you have a first mortgage, your HELOC won’t be very much. You’d have to refinance your HELOC to access the money you’re putting  into the first mortgage.

So if your house is worth $500,000 when you’re done with it and you get a $400,000 HELOC and a $50,000 HELOC on top of that (which is 90% LTV combined—difficult but not impossible to get). If you pay off $100,000 of your first mortgage, your HELOC is still $50,000. It doesn’t automatically go up to $150,000 just because you increased the equity in the house. You’d have to refinance the HELOC to increase your credit line.

Your plan could work if you just cash out refinanced your house with a HELOC as your first mortgage. Then, you’d have the $400,000 credit line and every time you put money in, you’d be able to take it out when you needed to. But your HELOC would have to be your only mortgage on the property.

Jean H. · Answer

Sorry. Typo.

So if your house is worth $500,000 when you’re done with it and you get a $400,000 *fixed first mortgage* and a $50,000 HELOC on top of that...

Craig Jeppesen · Answer

I don’t have a problem if you want to build a nice house; my main point is you are not getting a $400k heloc which is what your post implies.

Here are my personal rules for  Building a personal residence: no more than 25% of income to payment, don’t go so custom That you can’t resell, Find out how long $500 k homes take to sell in your area; what percent of people in your area can afford it if you will sell in the future. $500 k would sit for too long in my area and I would not do more than $350k here, but that is just me.

Good luck

Andrew Postell · Answer

@Joseph Niedermeyer we are trying to point this out but maybe we should try to do this in a different way:

• How much will you be borrowing to build this house?

It sounds like you are borrowing 70% of the home value to build the home.  So if your home is worth $500k, then 70% = $350,000.  You can only receive a HELOC after the home is completed.  Your COMBINED "Loan to Value" can only be 80%.  So if your pre-existing loan is 70%...then your new HELOC will be 10%....or $50,000.  Does that make more sense?

Craig Jeppesen · Answer

The math doesn’t quite work that way because you will have a mortgage. Let’s say you have $50K cash to buy a lot and can build a $500 k house for $350k that would give you a $100 k heloc. If you built a $150k house and got a $55k mtg you would get a $65 k heloc. So you go way more in debt to get $35k in credit. There are better ways to build equity and My guess is you are using the heloc theory to get a nicer house. If you want the nicer house do it because you want to not to invest more because you will be able to invest less.

I would use your discounts to do brrr projects instead.

Alex Furini · Answer

@Joseph Niedermeyer, A HELOC is a great option in my opinion to BRRRR. That being said, you need to have extra equity in your home to pull a line off of. Just remember that HELOC's are adjustable rates, So always know and accept the risk that the rates may go up making the payoff more difficult.

Best of luck with your project,

Alex Furini, RA

Joseph Niedermeyer · Answer

@Jean H.

I guess I thought that was a technical point that didn’t need to be stated. Yes, HELOC would be periodically refinanced as equity in my house grew. And yes, there’s a tipping point where I could pay off my first mortgage with my HELOC. Again, I made the assumption that didn’t need to be stated. My apologies.

We have relatively modest retirement goals, $2 - $3 million in rental property (paid off). We have approximately 20 years till retirement, so that’s 1 or 2 properties per year giving us plenty of opportunity to refinance the HELOC as our equity grows.

Joseph Niedermeyer · Answer

@Andrew Postell

Some portion of the house construction will be paid in cash along the way. Maybe $50k. But that’s not really my point. If I’m going to save up $20k to do a flip or brrrr, instead of leaving that cash in an account doing nothing for me, my plan is to pump that money into my first mortgage. When I’m ready to do a deal, the first mortgage will be paid down the additional $20k, accessible through my HELOC. Say I do a flip and net $40k, I put that money directly into my first mortgage, building my equity and increasing my HELOC. Each deal I do continues to drive down my first mortgage. I continue to make my regular mortgage payment and my HELOC payment from my day job. Any extra money or bonuses are also fed into my first mortgage, building my equity and my HELOC. Once my first mortgage is paid off, all monies are fed into keeping my HELOC as low as possible.

What are we missing?

Joseph Niedermeyer · Answer

@Craig Jeppesen

You are partially correct, we do want a nicer home. We also want a bigger home. We have 3 very young children. So sharing a room now isn’t the end of the world but as they enter their teenage years having separate rooms will just cut down on the drama. I also have an aging father with Parkinson’s who will likely end up living with us in the near future. Add a spare bedroom for out of town company and we are at 6 bedrooms. Up the number of bathrooms to account for the people and we are building a 6 bedroom 4-5 bathroom home. Add an extra garage bay or two now we have 3-4 car garage. Planning ahead for their teenage years, having a second separate living space or den just seems like a good idea. So we are not building a big house for the sole purpose of funding future deals. We are building a bigger house for the practical convenience of having a large family.

I could build 10x10 bedrooms that would serve their purpose but feel cramped. Or I could build 12x16 bedrooms that are much more comfortable. I could build 2 bathrooms for six people to share or build 4 or 5 bathrooms for the comfort and convenience of our family. I could build a small eat-in kitchen table area where we squeeze in elbow to elbow for meals or build a more formal dining room that’s suitable for 10-12 people so we always have have room holiday guests and family or friends at our table. All will ultimately add square feet and value to our home.

The idea of using a HELOC was to kill two birds with one stone. Instead of having to split my income to make regular mortgage payments (paying my personal off slower) and set money aside for deals, I can put all my income (and potential future proceeds) into my home which allows me to recycle that money relatively easily without having to refi over and over or find private money to keep the cycle going. Because it’s our personal home, where we will retire in 20 years and die in 40+, the cost to build it is almost not a factor since we will never see it sold. But with a HELOC, we can use the home as a tool for building our RE portfolio.

Again, this makes perfect sense to us. If we are missing something with how the process works, please do tell us.

Joseph Niedermeyer · Answer

@Andrew Postell

We are building a house regardless of having a real estate future, so that’s one point. Another point is I’ve been in the construction industry most of my adult life so we will be building the home ourselves, saving 10+% on whatever size home we build. And finally, my day job is outside sales rep for a large building supply company. As an employee, we get a fairly substantial discount on materials. Adding an additional 20+% savings on top of doing much of the work ourselves. If we buy the land with cash upfront, build the house at 70% discount and have no retail markup, we will start off with a fairly decent amount of equity.

Then, instead of putting money down on individual deals, we would simply funnel those down payments into our own home growing its equity. The more equity available, the more HELOC available. Use the HELOC to do deals. At the end of each deal (Flip or BRRRR) we put proceeds back into our homes first mortgage. After a few deals, the first mortgage is paid off and all we have is a HELOC at 80% of the home’s value.

This is why we want a larger, more valuable home. We could build a $100,000 home and figure out how to live in it. But an 80% HELOC is only $80,000 to do deals. That’s going to prohibit our real estate growth. If we build a nicer, somewhat larger home for $500,000 then an 80% HELOC is $400,000. We can do a lot more with that kind of flexibility. And we get the benefit of raising our family in a much more comfortable and spacious home. Average home price in our area is $158,000.

We understand that you can get creative with down payments, private loans, lines of credit, partners, etc, etc.... We feel like this would solve both issues in our immediate future. Wanting to build a nice home for our family and having money to do deals. We become our own bank (with a HELOC) and don’t have to stress over the initial monies to purchase and rehab a property. Once a property is market ready, it’s either sold (a flip) or refinanced (a BRRRR) . All proceeds are then put back into the original first mortgage allowing us to extend the HELOC further. Once the first mortgage is gone, all income and net proceeds are pumped back into the HELOC keeping it mostly paid down and available for the next deal.

As we approach “retirement” from my day job in 15-20 years, we will begin paying off the older mortgages on the rentals. Eventually having all of them paid off and increasing our cash flow for retirement. At that point, we can still do deals but we would likely use the HELOC to do the initial funding then pay off the HELOC with the rental incomes, never needing any other outside funding again.

If we built a $100,000 home we would forever be bound by its market value and not have a HELOC large enough to eventually self fund our own deals.

At least that’s our hypothetical plan. If there are holes in our plan, we are open to suggestions.

Using HELOC to fund deals ?

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