Let’s discuss HELOC. Getting a great return on your investment is the name of the game when it comes to buying rental properties.
I’ve previously discussed the BRRR Strategy, which allows you to recoup your initial investment, or have little to no initial investment at all, allowing you to achieve an abnormally high rate of return, or an infinite return.
In this article I am sharing another great investment strategy that I’ve used to increase my overall return on investment, and access the stagnant equity in my rental properties, allowing me to get a return on that equity.
What Is A Home Equity Line of Credit?
Let’s say you own a property that is worth $300,000, and you only owe $200,000. This leaves you with $100,000 in equity, which is the difference between the asset value and it’s liabilities.
We all know it’s great to have a lot of equity, but equity does not produce cash flow, or any kind of return. Another way to look at it would be having $100,000 in the bank, but not being able to spend it, unless of course you apply to access it.
That’s where the home equity line of credit comes in.
A home equity line of credit (also referred to as HELOC) is a loan against the equity in a property. Unlike a regular mortgage, the HELOC is in second position to the existing mortgage, so the rates are usually higher due to the increased risk.
HELOC’s are often interest only loans, and the fees are very low. Banks and credit unions offer HELOC’s on both primary residences (house you live in personally) and investment properties.
Most banks require an automated valuation method or a BPO, which stands for broker price opinion, to determine the current market value and the available equity in the property.
They will require a maximum loan to value ratio, and will not allow you to access all of the equity in the property, just a certain percentage.
Benefits Of Having A HELOC
Having a HELOC comes with a lot of benefits and flexibility.
If you have a great interest rate on a property that has a lot of equity, the HELOC allows you to tap into that equity and put that capital to work.
Basically you get the benefits of selling a property (access to capital) without having to sell, which would have you give up your income stream, and you’d have to pay taxes on any gains from a sale.
Even though a HELOC is still a loan, it can be used like income, yet the “income” is tax free. Meaning you can take $100,000 out of a property and put it in your bank account but you won’t pay any tax on it.
The other interesting benefit of having a HELOC is that when a HELOC gets recorded against the property, the entire loan amount shows up on title (even though it could have a zero balance) and this may warn off any blood sucking Personal Injury Protection Attorneys or other potential frivilous lawsuits.
I’ve been told that when a party wants to sue, the first thing an attorney does is search the defendents assets. If it appears that they have assets (such as real estate with equity) then they are more willing to take the case on.
If it appears the person owns real estate but the loan balances appear to be high, they may think twice.
The biggest benefit I see is that HELOC’s can replace the need for hard money loans, and allows you quick access to capital if an investment opportunity comes available.
Ways I’ve Used HELOC’s
I’ve used HELOC funds:
As a down payment on a conventional loan for a new rental property, allowing me to buy “zero down”
Instead of using hard money on flip projects
For remodeling existing properties
To make cash offers
The first HELOC I got was $54,500 and I immediately used it to fund the down payment on a new triplex. That triplex still cash flowed $900 per month after accounting for the HELOC payment, and the mortgage payment.
Others I know have used HELOC’s to loan out to other investors, allowing them to earn a much higher interest and earn passive income.
How To Get A HELOC
First things first, you’ll want to work with smaller, local banks for HELOC’s. Typically credit unions and these smaller banks are more willing to offer these types of products to their customers.
Each bank is different so make sure you ask to see what LTV (Loan To Value) they will require and how quickly they can process the loan.
In my experience, banks require a 70% LTV on investment properties (rentals where you do not live), and 90% LTV on a home you personally live in.
I do is look at my portfolio and calculate which properties had enough equity to get a line of credit. The formula I use is what I believe the current value to be multiplied by .70, subtract the first mortgage, which leaves the amount available for a loan.
Value x .70 = X – First Mortgage = Available Equity For A HELOC
In this example, I can hold on to this high cash flowing duplex I already own, and access $70,000 to buy more properties. If I were to invest the full $70k I could earn an extra $6,630 a year with this money (Assuming a 15% ROI minus 5.5% interest payment on HELOC).
You probably want to see at least $30,000 in available equity to get a loan from before you fill out the application with the bank. Depending on their valuation method, they may not value the property as much which would leave you with very little to get a HELOC on.
The application is quick and easy, my bank asked for the last years tax return and a financial statement filled out. Then they did the valuation, which was a BPO. The BPO came back within a few days, and we were able to close on the HELOC within a week.
The interest rate that I pay is 5.5%, and I have two HELOC’s on my investment properties. The rate and LTV is much lower on a primary residence.
Risks When Using HELOC’s
Every strategy has it’s risks, and using HELOC’s is no different.
The biggest risks I see when using HELOC’s is that the interest rate is variable and subject to change, and that the issuing bank can reduce the loan amount or cancel the loan at any time.
In the last recession banks were lowering credit and canceling HELOC’s on even the most qualified borrowers. It was too much risk for them to allow customers to access those HELOCs as the value of real estate declined. Those who relied on their HELOC suffered the most.
What About Being Over Leveraged?
The positive effect of the great recession is that we all learned the lesson of what can happen when we over leverage and use loose lending practices.
Every investor has their own opinion on what being over leveraged means. Keep in mind when the banks are offering HELOC’s they do require a significant amount of equity in the property, especially if it is on a non-owner occupied property.
The max loan amount of all loans on the property is 70%, so 30% equity is required to remain untouched which is pretty low risk in my opinion.
When I use a HELOC for an acquisition I always make sure the property will cash flow on a monthly basis with the first mortgage AND the monthly payment on the HELOC.