HELOC (Basics and Strategy)

Home Equity Line Of Credit

Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for investment advice.

?

Basics

?

A HELOC, is a revolving credit line, leveraged on the equity you have built. It is a second loan, separate from the current mortgage you already have on your home. This new credit line will not affect or change the amortization timeline of your initial loan or the fixed interest rate that you currently have established. Because a HELOC is a line of credit, you make payments only on the amount you actually borrow, not the full amount available.

?

When HELOC’s are set up, they typically have two periods; a draw period and a repayment period. The draw period is typically designed to have interest only payments while the funds are withdrawn. This draw period is usually set for 10 years with an annual loan maintenance cost of around $50-$200. The repayment period begins after the 10-year draw period with the payments including principal and interest.

?

Not all HELOC’s are created equal… Every lender has different thresholds for how they measure risk. Banks will weigh out such items as your credit score, reliable income, repayment history and most importantly, your DTI (Debt-To-Income) ratio.

?

Your loan-to-value (LTV) ratio is a major factor for determining how much money you can access with a HELOC. The LTV ratio is a measure comparing the amount of your mortgage with the appraised value of the property. The LTV is a borrowing limit your lender sets that is based on your home’s appraised value.

?

Focus needs to be placed on what lending thresholds each bank has. Some banks only do 75% LTV while others will do up to 95%. Another item to explore with the bank is the max total loan threshold. Although you might have $250k available within the set LTV (as an example), a bank might have a $150k lending cap, so it is important to explore those two limiting factors for each bank you are measuring.

?

Plug 1: This is not a paid advertisement and I do not get anything for this, but when I explored over thirty banks and credit unions, Pentagon Federal (PenFed) Credit Union was the best option for what I was looking for. At the time, I was most concerned about the highest LTV and the max loan cap. PenFed provided a 90% LTV with a max cap of $500k for line of credit.

?

Most (almost all) HELOC’s have a variable interest rate. This means that the rate changes over time (even month to month) and follows the current federal interest rate. The variable rate is calculated from both an index and a margin. Don’t get wrapped around this one point, but your HELOC rate will be a fixed margin set above the constantly adjusting index rate. Main point to take away is that you can pull funds out of your HELOC at one point and the repayment rate has the potential to swing higher or lower, even as much as doubling in just a year’s time.

?

The more you borrow against your property, the more you’re putting yourself at risk. Your home acts as collateral for the loan. A HELOC does allow you to borrow cash from the value of your home — but it is preferably for wealth-building expenditures; short-term duration with an intent of refinance to pay back the HELOC balance. It is a common opinion that HELOC’s should NOT be aimed to help financially in such cases as debt consolidation, consumer purchases, payment for medical bills or education loans. HELOC’s can be utilized for a wide array of expenses, but let’s look at some of the top leverage opportunities for HELOC’s that will keep you better positioned and yield a higher ROI (Return On Investment).

?

Strategy

?

HELOC’s are best served for short-term leverage opportunities, typically for value-add projects, with a plan to have the balance repaid within six months to a year. I do not like keeping that leverage out for long duration's of time. The way I approach this is accomplished by combining the HELOC as a down payment with the rest of the funding coming from private-money (hard-money) lenders, for value-add opportunities. When the project is complete, I will refinance the property into a conventional loan, paying back all previous loans borrowed, including the down payment made by the HELOC and the rest of the private money. There are many factors to underwriting a deal like this, but my highest priority is creating enough value (equity) in the rehab/construction to meet conventional lending terms and making sure I am lined up with a bank beforehand that will accept my projected DTI ratio. It is important that I am inquiring about this, before I start the project. You do not want to get in a position where you hit a home run with the project, create +35% equity but cannot refinance because you cannot qualify due to DTI thresholds. That consideration is for a buy, flip and hold position. You will not be as concerned for that variable if you have the fix, flip and sell strategy.

?

Once the money is paid back to the HELOC, you balance is renewed, and you do not have monthly payments due. This revolving credit line is standing by and available for your next value add project, once the opportunity presents itself.

?

Even if you are not in a position to pull off a value-add purchase and rehab now, it still may be a good idea to at least set up the HELOC and sit on it. So many times I have seen before when friends are looking to set up a HELOC on an investment property that they lived in previously. Although this possible, the typical LTV for HELOC’s regarding primary residence’s is around 85-95% but the cap LTV on investment properties is usually not more that 70%. If they would’ve set up a HELOC on the property when they lived there previously, they could’ve unlocked hundreds of thousands more. If you are a newer investor trying to get from your first home to two… or your second property to your third, a HELOC on you primary residence may be the tool that gives you an advantage to scale in the near future. ?

?

Last tip on strategy, watch out for teaser rates – this is an introductory rate that is unusually low for a short period, such as six months, but then reverts to a much larger rate after.

?

Plug 2: My process of underwriting and the utilization of Hard Money is a topic for another article. If you can’t wait, I would recommend you shooting an inquiry to Center Street Lending (CSL) and asking your initial questions for how they lend to investors. I have done multiple deals with CSL and highly recommend them as a private money (hard-money) lender. Shot out to Jeremiah Wiedman .

?

?

Cash-Out Refinance

?

Many times when looking to unlock equity a home, the two options individuals seek out are HELOC’s and Cash-Out refinances. There are benefits to cash out refinances, but I approach these two options by the cost of money. What I mean is that there are costs associated with different leveraging options. Let’s break these down in a couple general examples.

?

In a HELOC you will typically pay for costs such as an appraisal, credit report fee, document preparation fee, origination fee, notary fee and title search fee. For HELOC’s I have set up in the past, these costs did not surpass $2k for the loan I was applying for.

?

For a Cash-Out Refinance, you will pay all these same fees, but you will also pay points for the loan. A point is equal to 1% of the amount borrowed. You can expect to spend between two to four points of your loan amount for cash-out refinances, 3% is typically what I have seen.

?

Example:

You own a $1M home with a $700k mortgage on it. (Primary residence)

?

HELOC with bank that allows 90% LTV:

90% of $1M is $900k

Minus the current mortgage of $700k is a total HELCO available of $200k.

You might pay around $2k for the closing costs for this amount.

?

Cash out refinance will typically only allow up to 80% LTV, and that is being generous.

80% of $1M is $800k

Minus the current mortgage of $700 is a total cash out amount of $100k.

3 points cost of loan is 3% of the $800k loan, equaling $24k

Subtract the $24k from the $100k and you end up with $76k cash.

?

I do acknowledge that cash is better than leverage and there are many more variables to consider… But at face value, which provides you more buying power.

?

Just like most things in life, there is a push-pull reaction with decision making. The great thing about Real Estate is that you can put 20 investors in the same room and they may all approach a project/situation a different way. Unfortunately, I cannot cover every option available in a five-minute read. If you have an additional question or would like clarification on an approach I have taken in the past, please comment below. I hope that his article provided you a general scope of considerations to utilize in your search and use of a HELOC in the future.