Author Topic: Pros and cons of establishing a HELOC to invest in rental properties?  (Read 1552 times)

stacyknutson

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We are working on a plan to gradually transition to early retirement over the next few years. At the end of this year, we expect to have significantly reduced income due to me quitting work and my spouse dropping down to part time. We have been very interested in investing in rental property for many years, and we feel like now is the time to do it (before our income drops and it becomes very hard to get an investment property mortgage). We do still have our mortgage on our primary residence (the rate is very low at 3.375%), and we plan to keep that (it won't be paid off for another 15 years or so). We don't have any other debt.

We hope to find one or two small properties to purchase within the next six months or so. In addition, I would like to close our existing home equity line of credit (HELOC), which has only a $25,000 line of credit, and replace it with a new HELOC with a lower rate and probably about a $125,000 line of credit. I have two questions that I am looking for advice on.

  • We plan to get mortgages for the investment properties we buy in the next six months, and put 20% down. But, after we retire, I'm thinking the HELOC could help us to invest in at least one more small/inexpensive rental property, since we would be able to use the line of credit for it and not worry about getting a mortgage (which we probably wouldn't qualify for after we retire, due to lower income). I can see advantages and disadvantages to this. The disadvantages I can think of are that our primary residence is securing the HELOC, so there is some risk there. Also, the HELOC will have an adjustable rate (though it will be really low in the near future), and would need to be paid off sooner (probably) than a 30-year mortgage. Are there other advantages or disadvantages that I'm not seeing? I tried doing a quick Google search on this but wasn't able to find anything about this situation.
  • We are about to apply for preapproval on a mortgage for an investment property. I'm debating about whether it would be better to set up a HELOC now (before we do the preapproval for an investment property) or later (after we buy an investment property). The pros of getting a new HELOC set up now seem to be that we would have peace of mind knowing that it's ready and waiting, and it would be available if for some reason we wanted to make use of it between now and when we buy an investment property. The disadvantages might be that it would affect our preapproval (reduce the dollar amount that we would be preapproved for, maybe??) and that if our property appreciates in price between now and maybe six months from now, that extra home equity amount that we build would not be available in our HELOC. Does anyone know of any other reasons we should set up the HELOC now (before we are preapproved on the mortgage for the investment property) or later (in maybe ~6 months after we buy an investment property)?

Any advice you have would be appreciated.

rothwem

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Re: Pros and cons of establishing a HELOC to invest in rental properties?
« Reply #1 on: February 11, 2020, 06:03:37 AM »
People Iíve met that use Helocs for rental properties generally refinance after the purchase to get a lower fixed rate and to limit the exposure to their personal assets. 

The only other thing to mention is that the competition is super savage right now for inexpensive properties. Go ahead, try to find a cashflowing $100k property that isnít in a warzone or a busted former factory town with no jobs.

NonprofitER

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Re: Pros and cons of establishing a HELOC to invest in rental properties?
« Reply #2 on: February 11, 2020, 09:30:06 AM »
You may consider posting your question on Bigger Pockets forums (the RE website).  There is a higher likelihood of responses there.

FWIW, we are not yet retired but have used a HELOC to purchase rentals.  Most investors who use this strategy use the HELOC to buy a (fixer upper) property in cash, improve its value with a rehab, and then refinance it to pull the cash back out.  The rehab/improved value, if calculated correctly at the outset, provides enough equity to leave in the deal to satisfy the banks requirements (aka, the BRRRR - buy, renovate, rent, refinance, repeat). I would think being retired wouldn't necessarily effect your ability to refinance in this situation - esp if you're working with a lender who calculates the rental income against the 'debt' of the new mortgage. 

IE, lets say you use your HELOC to buy a property with cash at $100k in an area that generally commands $130-$150k for 3/2 SFH's.  You put another $15k into the property in a rehab. Rent out the property at $1400/mo, and then refinance with a local credit union who accounts for the rental income.  The bank usually wants you to leave 25% equity in the deal, but thanks to your rehab, your property is now worth $150k.  You refinance leaving 25% equity in, and set up a new mortgage on the property for $112,500 (pulling that cash out to pay off the majority of your HELOC and rehab, save a few thousand here or there).  Then your rental income is accounting for PITI + vacancies/repairs/capEx, etc. And you're ready to repeat the process, if desired.

These are obviously back of the napkin numbers, but that's the idea. In my opinion, its the smartest way to use a HELOC because you're only drawing down the funds for ~6 months at a time. 

I will have to humbly disagree with rothwem's perspective that all $100k cashflowing properties are in "war zones".  We live in a M-HCOL area (Austin) and purchase our rentals in another market (200k - 300k sized college town with multiple economic drivers and predicted growth).  We regularly see deals of 3/2 SFH's for around the $100-$115k mark that work to cashflow or add value using the BRRRR method and are in solid B+ areas.  We purchased two such deals in November and December 2019.  If your particular market isn't great for cashflow, you'll have to assess whether you're comfortable investing in real estate elsewhere. 

rothwem

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Re: Pros and cons of establishing a HELOC to invest in rental properties?
« Reply #3 on: February 12, 2020, 06:19:06 AM »

I will have to humbly disagree with rothwem's perspective that all $100k cashflowing properties are in "war zones".  We live in a M-HCOL area (Austin) and purchase our rentals in another market (200k - 300k sized college town with multiple economic drivers and predicted growth).  We regularly see deals of 3/2 SFH's for around the $100-$115k mark that work to cashflow or add value using the BRRRR method and are in solid B+ areas.  We purchased two such deals in November and December 2019.  If your particular market isn't great for cashflow, you'll have to assess whether you're comfortable investing in real estate elsewhere.

I didn't say that they didn't exist, just that its a pretty fierce competition. In most places, you're not going to just pick up a $100k cashflowing property off the MLS. 

stacyknutson

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Re: Pros and cons of establishing a HELOC to invest in rental properties?
« Reply #4 on: February 13, 2020, 06:41:33 PM »
Thank you for all the feedback. I wasn't aware of the strategy of using the HELOC to finance the property initially and then refinancing. I will definitely look into that and also check out the BiggerPockets site a little more closely.

Milspecstache

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Re: Pros and cons of establishing a HELOC to invest in rental properties?
« Reply #5 on: February 14, 2020, 12:47:10 PM »
I have done it for over 10 years now.

PROs:
Saves me interest because I am able to move money quickly back into the debt to reduce it whereas most people maintain reserves or savings, I try to minimize all accounts and pay the HELOC balance as low as possible.
Very easy to buy a house that is under your HELOC limit.  Very minimal closing costs and sometimes I can close within 2 weeks if the title search goes well.
If one offers a low teaser rate then I immediately max that one out.  This minimizes my overall interest rate.  Wells Fargo does this and it is probably one of their few good points...
Opening new HELOCs sometimes results in zero closing costs!

CONs:
Some individuals may find the easy cash too much of a temptation.  Certainly you should watch your balance frequently.  At one bank they made a mistake which allowed someone else to write a check to my account.
Added risk due to the adjustable rate.  Like the previous posts I am focused on getting a large fixed rate loan next to consolidate some of my HELOCs to get a low 30 year rate.
As you max out one (with the lowest rate) and apply for others you may cause your credit score to go down.  I am always chasing the lowest rate.
Very hard to put HELOC on non-owner occupied multi-family housing.
Slightly harder on income taxes to distribute between multiple properties.  Requires good record-keeping.

stacyknutson

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Re: Pros and cons of establishing a HELOC to invest in rental properties?
« Reply #6 on: February 15, 2020, 07:03:49 PM »
I have done it for over 10 years now.

PROs:
Saves me interest because I am able to move money quickly back into the debt to reduce it whereas most people maintain reserves or savings, I try to minimize all accounts and pay the HELOC balance as low as possible.
Very easy to buy a house that is under your HELOC limit.  Very minimal closing costs and sometimes I can close within 2 weeks if the title search goes well.
If one offers a low teaser rate then I immediately max that one out.  This minimizes my overall interest rate.  Wells Fargo does this and it is probably one of their few good points...
Opening new HELOCs sometimes results in zero closing costs!

CONs:
Some individuals may find the easy cash too much of a temptation.  Certainly you should watch your balance frequently.  At one bank they made a mistake which allowed someone else to write a check to my account.
Added risk due to the adjustable rate.  Like the previous posts I am focused on getting a large fixed rate loan next to consolidate some of my HELOCs to get a low 30 year rate.
As you max out one (with the lowest rate) and apply for others you may cause your credit score to go down.  I am always chasing the lowest rate.
Very hard to put HELOC on non-owner occupied multi-family housing.
Slightly harder on income taxes to distribute between multiple properties.  Requires good record-keeping.

This is really interesting. So do you have other income besides rental income? I'm wondering what the bank looks at when you go to refinance the HELOC balance. Our income will be pretty low after FIRE (so much so that our own mortgage payment would probably lock us out of qualifying for an investment property loan based just on that income). So I'm interested in finding out how we could possibly still refinance a HELOC balance in that situation. Do you have a lot of other (rental?) income that makes it easy for the bank to refinance for you, or do they just look at the rental income you've gotten on the property so far and approve it based on that (with maybe some reserves available for vacancy)? I'd love to hear more about how you do that, or any ideas you may have for other resources where I can learn more.

benolielgeorges

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Re: Pros and cons of establishing a HELOC to invest in rental properties?
« Reply #7 on: February 16, 2020, 06:52:50 PM »
have you looked into a  pledged asset line instead?

SwordGuy

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Re: Pros and cons of establishing a HELOC to invest in rental properties?
« Reply #8 on: February 16, 2020, 08:08:36 PM »
People Iíve met that use Helocs for rental properties generally refinance after the purchase to get a lower fixed rate and to limit the exposure to their personal assets. 

The only other thing to mention is that the competition is super savage right now for inexpensive properties. Go ahead, try to find a cashflowing $100k property that isnít in a warzone or a busted former factory town with no jobs.

Bought 2 last fall that would have cash flowed very nicely if they weren't earmarked for charitable purposes instead.

Milspecstache

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Re: Pros and cons of establishing a HELOC to invest in rental properties?
« Reply #9 on: February 20, 2020, 12:14:41 PM »

This is really interesting. So do you have other income besides rental income? I'm wondering what the bank looks at when you go to refinance the HELOC balance. Our income will be pretty low after FIRE (so much so that our own mortgage payment would probably lock us out of qualifying for an investment property loan based just on that income). So I'm interested in finding out how we could possibly still refinance a HELOC balance in that situation. Do you have a lot of other (rental?) income that makes it easy for the bank to refinance for you, or do they just look at the rental income you've gotten on the property so far and approve it based on that (with maybe some reserves available for vacancy)? I'd love to hear more about how you do that, or any ideas you may have for other resources where I can learn more.

Yes, I have other income and good credit.  But, I am FIRE in less than 4 months placing me in your situation.  Another reason why I have opened so many and also plan to finance one last 30 year fixed to zero out balances on the HELOCs before my credit becomes too bad.  They always ask for rental incomes so they definitely look at it but the ratio of debt to income is also important.  I think this will depend on the bank.  PenFed is my current favorite if you are military/government employee.

FireAnt

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Re: Pros and cons of establishing a HELOC to invest in rental properties?
« Reply #10 on: February 26, 2020, 08:23:15 PM »
I have done it for over 10 years now.

PROs:
Saves me interest because I am able to move money quickly back into the debt to reduce it whereas most people maintain reserves or savings, I try to minimize all accounts and pay the HELOC balance as low as possible.
Very easy to buy a house that is under your HELOC limit.  Very minimal closing costs and sometimes I can close within 2 weeks if the title search goes well.
If one offers a low teaser rate then I immediately max that one out.  This minimizes my overall interest rate.  Wells Fargo does this and it is probably one of their few good points...
Opening new HELOCs sometimes results in zero closing costs!

CONs:
Some individuals may find the easy cash too much of a temptation.  Certainly you should watch your balance frequently.  At one bank they made a mistake which allowed someone else to write a check to my account.
Added risk due to the adjustable rate.  Like the previous posts I am focused on getting a large fixed rate loan next to consolidate some of my HELOCs to get a low 30 year rate.
As you max out one (with the lowest rate) and apply for others you may cause your credit score to go down.  I am always chasing the lowest rate.
Very hard to put HELOC on non-owner occupied multi-family housing.
Slightly harder on income taxes to distribute between multiple properties.  Requires good record-keeping.
Can you clarify the bold portion? How do you handle repairs or other unexpected expenses without reserves?

Milspecstache

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Re: Pros and cons of establishing a HELOC to invest in rental properties?
« Reply #11 on: March 04, 2020, 12:06:00 PM »
I have done it for over 10 years now.

PROs:
Saves me interest because I am able to move money quickly back into the debt to reduce it whereas most people maintain reserves or savings, I try to minimize all accounts and pay the HELOC balance as low as possible.
Very easy to buy a house that is under your HELOC limit.  Very minimal closing costs and sometimes I can close within 2 weeks if the title search goes well.
If one offers a low teaser rate then I immediately max that one out.  This minimizes my overall interest rate.  Wells Fargo does this and it is probably one of their few good points...
Opening new HELOCs sometimes results in zero closing costs!

CONs:
Some individuals may find the easy cash too much of a temptation.  Certainly you should watch your balance frequently.  At one bank they made a mistake which allowed someone else to write a check to my account.
Added risk due to the adjustable rate.  Like the previous posts I am focused on getting a large fixed rate loan next to consolidate some of my HELOCs to get a low 30 year rate.
As you max out one (with the lowest rate) and apply for others you may cause your credit score to go down.  I am always chasing the lowest rate.
Very hard to put HELOC on non-owner occupied multi-family housing.
Slightly harder on income taxes to distribute between multiple properties.  Requires good record-keeping.
Can you clarify the bold portion? How do you handle repairs or other unexpected expenses without reserves?
With HELOCs you need no reserves.  Any extra cash I have goes into the HELOC and pays down the debt.  When an expense comes up, I pull the money out.  Most months I can deposit 1-2k extra.  Then when real estate taxes come due, I write a check for $3k, then immediately begin paying extra again.  I am all about finding ways to reduce my interest expense.