‘Cash Out Refinance’ or HELOC?

Question

I’m wanting to buy my first rental property this year. I’m about a month out from finishing renovations on my personal residence. My plan was to in a way to do a  BRRRR except that I would continue to live in the property. I bought the house over 2 years ago for $142,000 and currently owe about $124,000. When I’m done renovating I believe the ARV to be around $180-190,000. My plan was to do a cash out refinance, then get a hard money loan and buy my first rental to BRRR.

My question is would it be better to do a cash out refinance or to take out a Home equity line of credit to put towards the rental?

Andrew Postell · Answer

@Mike Dodd since your profile mentions you are in Texas I'll assume your primary home is in Texas as well.  Texas cash out loans are governed very differently here than any other state.  Make sure you are speaking with Texas based lenders on this subject.  Bigger Pockets also has a very active Texas forum if you ever want to post in there about anything Texas specific.

The "Loan to Value" is the same in Texas for a cash out loan and a HELOC - 80%.  So one won't provide you with more money than the other.  When we analyze a mortgage vs a HELOC here's what I would suggest to consider:

A mortgage will have a fixed rate.  A HELOC will have a variable rate.  A mortgage will have closing costs.  A HELOC usually has hardly any closing costs (maybe $500).  A HELOC I'm not paying interest on it unless I use it.  So if it takes me 9 months to find a property....well, that's 9 months I'm not paying interest.  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. With rates moving higher, it is likely that your rate will increase in the future. The 10 year maturity date is where the HELOC will modify into a different product all together. Meaning after opening the HELOC for 10 years 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 is matures the rate will increase. I've seen typical numbers of 1%-2% higher than your current rate.

Summarily, a HELOC is not designed to keep a balance on it long term.  A mortgage is.  Since the mortgage is a fixed rate product you will always know what your payment will be. But if you have a plan to pay a HELOC back quickly, you won't get caught if something adjusts.  That's why house flippers like HELOCs so much.  You use it - pay it back.  Use it again - pay it back and so forth.

Anyway, I hope this helps in some way about how to analyze the two.  Feel free to ask anything additional if you need.  Thanks!

Whitney Hutten · Answer

@Mike Dodd It depends on what the bank would give you on the cashout.  You most likely will have access to more funds on a HELOC as cashout refis in this environment tend to be lower LTV.  If you are going to BRRRR a HELOC is great to get started with.  My word of caution, be careful of overleverage and ensure that all properties cashflow very well.  Also, carry large cash reserves (more than you think right now).