Home Equity Lines of Credit, more commonly referred to as HELOC’s, got a bad rap a few years ago. During the last housing boom, many people realized they had a large amount of equity in their home but did not want to have to sell to access it. Enter the HELOC. Many banks were willing to allow home owners to establish lines of credit that were secured by the home itself. Most of these lines have a “draw period” of about 10 years, after that the money is owed back. Due to the fact HELOC’s are secured by real property (the house with all that juicy equity), the interest rates are often very low and very enticing. Now, for the intelligent investor who is using this money to buy assets that generate income, this is a great opportunity! The problem is most people did what most people will do. They pulled money out to buy boats, jetskis, big cars/trucks, trailers, and time shares. Some made home renovations or built swimming pools. Things that are NOT income generating. As you can guess, when that 10 year draw period ended, there was no money left to pay back the bank. Enter more home foreclosures, ruined credit, and crushed dreams.
HELOC’s got a bad rap.
The thing I’d like to point out is, the fault isn’t with the HELOC, the fault is with what the money is used for! Today I’d like to talk about a seldom used method to purchase income generating assets, but a very effective one if used wisely.
COSTS OF A HELOC
A HELOC is typically a low interest rate loan secured by the property. The amount of the loan is typically determined by the amount of equity in the property. If the minimum payment is not paid back to the bank, the bank can foreclose and take the home. It is typically a second position lien with terms different than the standard 30 year amortized loan. If you don’t make the minimum payments, or don’t pay the loan back in full at the end of the term, the bank may be eligible to take your house. That’s not good. Some HELOC’s are interest only payments, meaning, the principal is never reduced because the payments only go towards the interest. For those not disciplined who don’t have a plan to pay back the principal, this can be a bad thing. A standard amortized loan includes both principal and interest in the payment, so discipline is not as important. The biggest areas of concern with a HELOC is the risk of losing the home if the loan is not repaid (just like any other mortgage) and the fact some HELOC”s include interest only payments.
BENEFITS OF A HELOC
Now this is the good stuff. A HELOC can be more beneficial than a typical mortgage because it includes very low or no closing costs. Some HELOC’s do not cost anything at all to open. The money can be very easy to access as well. Sometimes it’s as simple as transferring money from your HELOC account to your checking account and the money is right there. Another benefit is the fact you don’t pay to use the money if you don’t draw against the account. Don’t need the money? Let it sit there and don’t touch it. You won’t pay the time. Have something come up where you need access to those funds? Emergency vehicle repair, awesome investment opportunity? You can access the cash immediately. The flexibility of a HELOC is one of it’s best features. Considering the fact this is equity you already had and do not need to sell your property to access it, a HELOC is an awesome option for the first time real estate investor who wants to use the cash to buy an investment property or a seasoned investor who does this all the time.
BUT HOW DO I USE MY HELOC TO MAKE ME MONEY?
The math is really simple on this one. Most HELOC’s have very attractive interest rates. I pay 1.5% on my primary residence and a few points higher for investment property lines. If an investor is able to obtain an 8-12% return on money it costs them 1.5% to borrow, you don’t have to be a math wizard to see this works in their favor. The simplest method is to buy an investment property with cash pulled from the HELOC, and use the monthly cash flow generated from the investment property to pay off the HELOC. If the 10 year draw period is up and money is still owed on the HELOC, simply taken a small mortgage out on the investment property that was purchased with all cash and use that to pay back the amount still owed on the HELCO. Voila, you now have a cash flowing property you used none of your own money to buy.
Not enough equity in your HELOC to buy a place all cash? Use the HELOC to make the down payment on the investment property. The cash flow from the investment property can still be used to pay back the HELOC. This can be a great method for people to get started investing in real estate who don’t have much cash saved up but own their own home and have built up equity from years of making mortgage payments or their home appreciating in value. Of all the ways to get started, this can be the most painless and simple way to get your feet wet with less risk than borrowing money from a hard lender at a high rate with expensive fees.
I use HELOC’s on my investment properties for all kinds of different ways to generate income. Money can be pulled out and used to fix and flip properties then paid back when the properties are sold, used to make repairs on newly purchased investment properties to increase the value and therefore increase the amount that can be obtained on a mortgage, money can be lent to other investors at a much higher rate than the HELOC costs, mortgage notes can be paid for at a higher interest rate than the HELOC costs, etc. The possibilities are endless.
If you’re going to be serious about your future, you need to be serious about your financial decisions today. If you’re going to be a serious investor, you need to continue looking for ways to maximize the resources you have at your disposal. Tapping into the equity in your properties (the result of good decisions and hard work) to help make you additional capital is a wonderful way to supercharge your results and see them come to fruition much faster than they would have without it.