Hey there all you potential, new and experienced investors.
Thanks for taking the time out of your busy day to stop by and read up on our blog posts. The topic today is hopefully one that can help you out of this beginning rut of not having any capital to help you with the first steps of real estate investing. You can also view our video about this topic here.
Have you ever found yourself in this place where you were super motivated about the idea of
getting into investing in real estate but you just couldn’t seem to come up with that lump sum
of money for the down payment?
Have you researched about investing and realized you either need to pay all cash or at least 20% down for a conventional loan and thought there was no way you could scrounge up that kind of cash?
HELOC vs. Cash Out Refinancing
I want all of you beginner investors to know that there is in fact a way to come up with capital quickly rather than having to pinch pennies for X amount of years by using some of the resources you may already have on hand…. Equity! Equity is the difference between what you owe on your mortgage and what your home is currently worth.
Let’s Talk HELOC
HELOC stands for Home Equity Line of Credit. A HELOC is a line of credit secured by your first
mortgage that gives you revolving funds to use when needed. You are given a maximum limit to
access as you choose. Once you pay off X amount you are then able to withdrawal that money
again and continue to pay it down over time. A HELOC is usually used for short term expenses
like down payments, an update on a home, etc. You are given a draw period which is generally
around 5-10 years. During this draw period you can take out however much is needed up to the
limit during which time you are only paying on interest (unless you decide you want to make
extra payments toward principle.) Once the 5-10 years is up, you can longer withdrawal funds
(unless you go to the bank to renegotiate) and you start on your 10-20 year repayment period
paying principal and interest payments. Although for banks there is no standard, minimum or
maximum LTV (Loan-to-Value) percentage for a HELOC, lenders will usually allow you 75-95% LTV. Typically, a
home owner needs around 20% equity in their home in order to qualify for a HELOC. In order to
obtain one of these you will want to go through a local lender, credit union or a bank that you
already have your first mortgage through.
Let’s say you have a home that has a market value of $300,000.00 and you still owe $200,000.00. This means that you have $100,000.00 worth of equity in your home. In this example, let’s say that the lender will allow you to borrow 90% LTV. In this case 90% of $300,000.00 is $270,000.00. You then subtract out what you still on the home and you are left with $70,000.00 to take out for a HELOC.
CASH OUT REFINANCING
Cash out refinancing is another option available to you if you have a mortgage. There are several reasons someone may refinance their home but for the sake of staying on topic we are going to discuss why it is helpful for you and your investment journey. Again, you’re in a predicament. You are trying to invest in real estate and you just don’t have that capital to get you your down payment. This is where refinancing your first home mortgage comes in. Once you refinance, the remaining balance on the home is paid off, fees for refinancing and taxes are paid, you get a new loan amount with a lower interest rate and the equity that you acquired from your first home thus far is given to you in one lump sum to do with as you wish, which in this case would be the down payment for your investment property. With cash out refinancing you are going to have access to around 75-80% LTV (again, no standard) as opposed to a higher percentage LTV with a HELOC.
Now let’s compare the pros and cons of each to see which route may be better for you and
your financial goals.
Pros of a HELOC
- You could have access to around 90% of your LTV, meaning if you have quite a bit of
equity in your home, you can open a line of credit for a higher amount as well!
- You don’t have to take out one lump sum. Spend what you need, pay it down and pull
out more if needed.
- A HELOC has little to no closing costs.
- The first 5-10 years you are only paying on interest if you so wish so the payments are
smaller in the beginning.
- Lower cost than many other types of loans.
Cons of a HELOC
- You’re going to get a variable interest rate so it fluctuates based on the index or
- Your line of credit is secured against the value of your home equity. If for some reason
you weren’t able to make payments on your HELOC, they could come after your home.
**Side note- A way to ensure you are strategically investing your HELOC to mitigate this
risk is simply to invest in cash flowing properties where the cash flow will easily cover
the HELOC payment.
- The repayment period could come as a shock to you after your draw period is up if you
have only been paying on interest. What was once a 50 dollar a month payment could
be significantly more in the repayment period.
- You may run the risk of spending more than you’re financially comfortable with if not
careful. You start to withdraw and get excited when you realize the interest payments
are small and end up overspending. Be careful and plan this out!
Pros of a Cash Out Refinance
- Fixed and lower interest rate
- Great for long term investments
- Possible tax deductions
- Longer repayment period
Cons of a Cash Out Refinance
- You can’t access as much equity as you would with a HELOC
- You will pay closing costs if you refinance
- You have to take the money in one large sum even if you didn’t want the full amount at
- Your principal and interest payments start the second you refinance making your
payments larger than they would be with a HELOC
Now that we ran through what exactly a HELOC is, a cash out refinance, the pros and cons of each and what they could do for you financially, I hope that you can make a better fitting decision for you and your RE investment needs. The main point of this blog is to put your mind at ease knowing that there is in fact something out there that can help you gain capital quickly. Many potential new investors call it quits before they even get started because they believe that if they don’t have the money sitting in their savings account that there is no hope. My goal with this blog is to help you better understand these financial terms which in turn will help you decide to make the decision to start investing sooner rather than later with options that benefit you and that may have been sitting right under your nose the whole time.
Thanks for stopping by today and checking out our blog. I hope this information
was useful to you and if you have any questions that I didn’t cover or something
that I said sparked an idea, please contact us at RentToRetirement.com and we would be more than happy
to assist you!