Real Estate Investing 101: What is a HELOC?

Or, how I got my first property

There are many ways you can fund investment properties that don’t have to include your long-awaited piggy bank. Borrowing and leveraging money can help you grow your investments without losing your cash and with favorable terms.

A Home Equity Line of Credit or HELOC

A home equity line of credit, or HELOC, is a type of bank loan that acts as a line of credit, which allows you to borrow against the equity in your home without impacting your normal mortgage or having to refinance.

Instead of giving you all the money loan at once, the bank allows you to use the equity in your home like a credit card. This allows you to pull out only the amount you want, in the timing that you want. It is flexible and very inexpensive to open which makes it an excellent way to borrrow money.

How it Works

  • The bank will determine how much you can borrow based on the value of your home (see LTV below).

  • The bank gives you a window (typically 5 years) to withdraw the money you need. You can withdraw it all at once or a little at a time or various amounts over that draw period for various projects or investments.

  • You are only required to pay interest on the money you withdraw. This is a huge benefit as it doesn’t act as a normal mortgage where you pay principal AND interest. This makes your monthly payments significantly lower, but you have to pay back the principal by the end of a period determined by the bank so don’t get too ahead of yourself!

  • If you withdraw some money, and then pay that money back within your draw period, you can then simply borrow that money again!

  • Interest rates on the loans are typically higher than standard mortgages and have variable rates (i.g.: Prime +1). This can be tricky to plan for, but the flexibility of borrowing far outweighs the downsides of interest rates.

Loan-to-Value

To qualify for a HELOC you need to have equity in your home, which means that the market value of your home has had to increase since the time you bought it (it’s worth more than you owe). A bank typically will loan between 85%-95% of the value which is their LTV (loan-to-value) policy.

An Example

Here’s how it works:

  • Let’s say you own a house that has appreciated over the years and is now worth $500,000. You have a primary mortgage that you make monthly payments on and the balance on that loan is $200,000. This means that you have $300,000 in equity in your home!

  • You could sell your home and make money, but you don’t want to move. You could refinance with the bank and create a new loan but interest rates are higher so you don’t want to do that! This is where the HELOC is a great option!

  • You meet with a local bank or credit union and their policy is 85% LTV (Loan-to-Value) which means they will give you 85% of $300,000 which is $255,000.

  • They set up your line of credit for $255,000 with a 5-year draw period. This means that within 5 years you can pull all of that money out, or even just $5,000, as many or as few times as you need.

  • Once you pull any money out, you are charged the interest on that amount only. You do not pay interest on the full $255,000, only on what you pull out.

  • You can pay off the money you pull out in a short time or wait until the end of the draw period.

What you can use it for

  • Typically, HELOCs are used for larger expenses that you do not want to use up your cash for - home renovations or repairs, college payments, weddings or to consolidate debt from credit cards, etc.

  • Some banks allow you to use it for investment purposes, which is how I got my first property. Being up front with your bank about your intentions with the money helps them determine the best loan and rate to give you.

How I got my first rental property

In 2016 we had enough equity in our home that we determined we could open a HELOC. We used some of the HELOC money to pay for a new furnace on our house and the rest of the money we used as a down payment for our first rental property.

When we decided we were ready to invest in real estate, we called a few friends first to see if anyone would be interested. Yes, investing with friends comes with risk, but it also comes with the benefit of having someone split the costs and headaches of owning property. One friend told us no, which was fine! But then we found a resounding “Yes!” with another friend/couple that we trusted and off we went. They pulled money out of their HELOC and suddenly we had money for a downpayment on a townhome. We had to pay the interest payments on the HELOC, but that was offset by the income produced by the new rental.

Eventually, we sold our personal home where the HELOC was attached, and at closing the Title company closes on both our original mortgage and the HELOC so we ended up with a rental unit without using our own cash and only paying interest payments on the loan until paid off by selling our home (which is not always typical as people do not move from their primary house that often, but it is an option!).

Let’s Get to Work

Investing should be fun (and profitable). Let me help you run the numbers and figure out what best works for your investment vision.