A HELOC is one of the methods I've used to acquire real estate over the years, and it's probably my most popular approach. It's a home equity line of credit that allows you to buy assets based on the equity in your primary residence. There are even lenders who will give you a line of credit on an investment property!
Now, there is a difference between a HELOC and a home equity loan. So let's talk about the differences.
With a HELOC, you establish a line of credit on your home. And with this line, you can withdraw cash. Think of it like a credit card. You can draw money from that anytime that you want to use the funds for any reason. Now, with a home equity loan, you're borrowing a fixed amount. The bank says, "I'll give you $100,000, but that's it. You can't take out another dollar." So using that equity to buy an investment property is like having the equity in your entire home when you make deals with lenders for investing purposes.
One of the main benefits of using a HELOC as part of your real estate investing strategy is that it can be easier to qualify for. Typically, underwriters look at two numbers: how much do I owe now, and how much do I make? And when you have a HELOC, it's not going to impact the first number-- just your income.
So if you have a line of credit that is $60,000 and you're drawing out only enough money to service the new property, they're not going to see $60,000 worth of debt. They're only going to see the new portion that you've drawn against it.
Typically, HELOCs have higher interest rates than a traditional home equity loan because they are established for short periods of time-- typically 3 to 5 years-- with the idea that you'll pay it off before the rate adjusts.
I really like HELOCs since they're similar to a recurring line of credit. A line of credit, as the name implies, is a line of money that you borrow from a lender. When you apply for one, they look at the value of your home and give you a certain amount of money. Then, whenever you need that money, you go online and pull it out.
Traditional home equity loans, on the other hand, require that you pay off the whole loan in one chunk with a single payment. A HELOC lets borrowers "tap into" their line of credit as needed.
Despite what others believe, your primary residence is not an asset. Rather, its a liability. No one is paying us to live in our home. However, HELOC's provide an interesting wrinkle in that you can leverage your home to purchase performing assets.
If you have a home that you live in, and start to turn it into a vehicle to help you buy performing assets, in a sense, your home is no longer a liability. So I go to a local bank and I inform them that I would like to open up a home equity line of credit on my property. They'll evaluate the property and if all goes well, I'll have my line of credit.
Immediately, you're starting with a $0 balance on that line. You do not have any payments to make until you start drawing against the loan. With a traditional loan, you're paying immediately, and often only paying interest upfront. You might pay all interest for the first 6 or 7 years of the loan. That's the beauty of a HELOC. If you're not quite ready to utilize it, you won't be paying for it.
Why would you want to utilize this approach rather than cash? Well, perhaps you don't have much saved up. In that case, the HELOC is a great alternative. Even if you did have the cash, would you want to tie it up into another project if you didn't have to?
When you buy, you want your tenant and the cash flow to cover the amount you're paying back on your HELOC. If you get a HELOC for 4% interest, but your cash flow sits somewhere around 10%, you're in a decent place. You would have enough to cover taxes, capital expenditures, and property management if you choose to go that route.
With every monthly payment, you are increasing your equity once again, building up enough that you can go right back to your local bank. Rinse and repeat.
So you may be thinking to yourself, I have a home equity line of credit and found an investment property that I'd want to buy. Writing a check from your line of credit is exactly the same as with a cash purchase. And the added bonus is that buying with cash will help you close considerably faster since there is no mortgage involved.
So in using the HELOC strategy, the bank has permitted you to amass wealth by leveraging their own assets—namely, the equity in your house. It's an incredible deal! Rinse and repeat, using that money to purchase rental properties and grow your portfolio.
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