Using a Home Equity Line of Credit to Buy Properties

A home equity line of credit (“HELOC”) can be an excellent financing tool, if it is used properly. A HELOC is basically a credit card secured by a mortgage or deed of trust on your property. You only pay interest on the amounts you borrow on the HELOC. If you don’t use the line of credit, you don’t have any monthly payments to make. You can access the HELOC by writing checks provided by the lender. In most cases, it will be a second lien on your property.

HELOCs are being advertised on television as a way to consolidate debt, but can be used much more effectively by investors. When you need cash in a hurry for a short period of time, a HELOC can be very useful. For example, if a seller tells you, “give me $75,000 cash on Friday and I’ll sell you my house for a song,” you need to act in a hurry. Another example of cash in a hurry is a foreclosure auction, which, in many states, requires payment at the end of the day of the auction. When you need cash in a hurry, there’s no time to go to the bank.

While the HELOC may be a high interest rate loan, it is a temporary financing source, which can be repaid when you refinance the property. Do not use your HELOC as a down payment or any other long–term financing source – it will generally get you into financial trouble. If you don’t pay the HELOC, you can lose your home!

Some institutional lenders will not lend you the balance if you borrowed the funds for the down payment. However, smaller commercial banks that “portfolio” loans have more flexibility and may allow you to use HELOC money as a down payment. Once again, I must caution you about using borrowed money in this manner – only do it if the deal is a steal and you can pay off the HELOC money within a few months.

DEDUCTING HELOC INTEREST

There are limits on the deductions you can take on your personal tax return for interest paid on your HELOC. Generally speaking, you can only deduct that portion of interest on debt that does not exceed the value of your home and is less than $100,000. But, if you do your real estate investments as a corporate entity, you can always loan the money to that entity and have the entity take the deduction as a business interest expense. This transaction must, of course, be reported on your personal return, and must be an “arms–length” transaction (i.e., documented in writing and within the realm of a normal business transaction). Consult with your tax advisor before proceeding with this strategy.

USING CREDIT CARDS

You may already have more available credit than you realize. Credit cards and other existing revolving debt accounts can be quite useful in real estate investing. Most major credit cards allow you to take cash advances or write checks to borrow on the account. The transaction fees and interest rates are fairly high, but you can access this money on 24 hours notice. Also, since credit card loans are unsecured, there are no other loan costs normally associated with a real estate transaction, such as title insurance, appraisals, pest inspections, surveys, etc.

Often, you will be better off paying 18% interest or more on a credit line for three to six months than paying 9% interest on institutional loans, which have up front costs that would take you years to recoup. Again, use credit cards carefully and only as a temporary solution if the deal calls for it.

HELOC VS HELOAN

What is the difference between a HELOC and a HELOAN?

HELOC = home equity line of credit
HELOAN = home equity loan

A HELOC will almost always be an adjustable rate mortgage that acts as a line of credit secured against your house. In some cases you might get a check book, or even a debit card to make "draws" against accumulated equity.

For instance if your house is worth 400k, and you have a first loan of 200k, you could very likely obtain a HELOC with a maximum amount of 100k. The benefit is that you can draw that 100k as needed. For example, if you draw $0.00 to start, you'll have $100,000 of credit, waiting to be tapped, tied to your home equity. You could draw $5.00 to buy lunch or $500 to buy a barbecue, or even $50,000 to buy that boat I've always wanted.



Your payments will then be based on the amount borrowed and the interest rate. This will almost always be simple interest based on the PRIME rate (8.25% for this example) plus or minus a fixed margin. In other words, if your margin is Prime + .75. and you borrow 100,000. then your payment would be:

100,000 X 0.09 = 9000

Then divide by 12 to get payment of $900.

A HELOAN is the same thing except you cannot draw against it. It's a one time deal, usually a fixed rate, and for all intents and purposed is analogous to a first mortgage. The only real difference is that the interest rate on home equity products is generally higher.

Some people have begun to refer to HELOC and HELOAN interchangeably. If it's a situation where it makes a difference to you, such as someone talking about a loan you qualify for, it would behoove you to clarify.

HELOANs generally offer lower fixed interest rates, whereas HELOCs provide the flexibility of being able to be used as a line of credit, but are variable rates. A HELOC is an integral part of many "Mortgage Acceleration" products.

Finally, be aware that many HELOCS offer the ability to draw a portion of the available balance and "lock it" thus turning that chunk of money into a HELOAN.