How To Use Your Home Equity Line of Credit (HELOC) To Buy Real Estate
A common tool or a common financial vehicle that a lot of people use when investing in real estate is what’s called a home equity line of credit or a HELOC for short.
A Home Equity Line of Credit is a Line of Credit that uses your home as collateral. There is a lien placed on your home similar to when you have a mortgage. The difference is that you only have to pay interest on the outstanding balance of the Line of Credit.
The Line of Credit gives you access to funds when you need them. The balance can vary from month to month similar to a credit card balance. The big difference between a LOC and a Credit Card is that you don’t have access to the funds when you want to make purchases at a retail outlet. That being said. some banks can link your credit card to your Line of Credit so you are getting the funds from your LOC at a much lower rate.
A HELOC can be secured by your personal residence or any other property you own.
So let’s say your home is worth $500,000 and you apply for and get a line of credit for let’s say, 80%. That means you now have access to $400,000 in your HELOC.
What some people will do is they will take an advance on that line of credit. Meaning they will actually take money out to fund their investments.
Let’s say they take $100,000 out. They can then use that as a down payment towards the purchase of another investment property.
This is how a lot of people get started. They purchase their first real estate investment using their home equity line of credit. The good news about a home equity line of credit is usually it is at the rate at which you can get mortgages which is the current prevailing mortgage rate. Usually, it’s a variable rate, but that’s okay.
HELOC rates are a lot cheaper than if you were to go into a bank and just ask for a loan to buy a car.
For example, let’s say loans for cars or standard consumer loans are 6%, 7%, or even 8%. Mortgage and HELOC rates can be in the range of 2%, 3%, or 4%. So it’s almost half of what you would get if you were going in to try to get a consumer loan. That is a big advantage.
The disadvantage of using a home equity line of credit, when you go to buy an investment property, is that you have to service that debt, meaning you’re going to have make monthly payments on that HELOC debt.
For example, in the case of a $100,000, your monthly payments maybe let’s say $400 or $500, or $600 a month to pay for that loan. That loan payment is on top of the first mortgage that you are going to get when you buy that rental property.
So you have this additional expense on the rental property for the down payment.
Let’s say that payment is $300 a month. Plus you are going to have your mortgage payment for the actual 1st mortgage … the one you took out for the property itself. That could be another $1,000. You then add in all the other expenses.
Because you borrowed the money for the down payment, and when I say borrow, you actually used funds from your line of credit. You end up having a situation where your expenses may exceed the rent, which means you are now operating at negative cash flow.
This is what happens a lot of times and people don’t understand this approach. And they say, well, I’m just going to take a loss while I let the property appreciate … assuming that the property appreciates. That’s the wrong thing to do.
When you purchase a property for investments, you want to make sure that it cash flows right from the start, even with all the finance in place, even with all the expenses in place.
