How to Fund Your DealsBy Paul Esajian on March 8, 2019
One of the biggest hurdles for new investors is finding ways to fund their deals. They haven’t yet established a relationship with a hard money lender and are striking out looking for a private lender. Instead of giving up hope, you may have a great resource sitting right under your nose.
If you own a property, and have equity, you may qualify for a home equity line of credit (HELOC). HELOC’s were prevalent last decade prior to the mortgage collapse and have slowly started making a comeback in recent years. For the ease, availability and simplicity afforded by a HELOC they are not without a handful of potential drawbacks. Deciding on whether to tap into your equity depends on the property, market and potential return on your equity. If you are looking for a way to fund your next deal, you should always investigate using a HELOC. Here are five things you need to know about utilizing equity.
- Availability. Simply put, a HELOC is a new second mortgage based on the equity of your property. You can use a HELOC on primary or investment property based on your credit score and something called your debt to income ratio. The lender adds your existing mortgage to the proposed second mortgage and divides that by the appraised value. This number typically needs to be under 75% to qualify. If approved, you will be given free reign over the capital. Instead of getting a lump sum check at the closing you are given a checkbook to use at your discression. If you want to write a check for an $80,000 property, the funds are there to use. If you have the line and want to wait for an opportunity to present itself, you can do that as well. Once your line of credit is in place, you can quickly access the funds whenever you need them.
- Interest Only Option. One of the most attractive features of a HELOC is the interest only repayment option. Most HELOC terms are twenty years with the first ten having an interest only option. On a traditional first mortgage you are paying principal and interest every month. When you eliminate the principal portion, you are left with a much smaller payment. This is important if you are looking at short term projects where you need to keep your expenses to a minimum. Obviously, there are some long-term repercussions (which we will get to) but for the initial ten years it can be a powerful tool that will help your business grow. The difference between an interest only payment on a $100,000 HELOC withdrawal can be as much as $150 a month less without the principal. If used properly, you can utilize debt to your advantage without high interest loans or other restrictive det instruments.
- Equity Reduction. As great as it is to be able to use your equity whenever you like, it is not without some drawbacks. For starters, the loan comes from the equity in your property. With that you now have a new loan added on title that must be accounted for. This may not come into play any time soon, but if you are considering refinancing or selling, it is a major factor. This is especially important if you are in a volatile market. In these markets is not out of the question for a property to lose a large chunk of value. If so, you will be stuck with limited, or no, equity backing you into a corner when it comes time to sell. The plan should be to use your equity to either close a deal that yields a higher return or to grow our business, but you should consider the downside when taking any equity out of your home.
- No Fees. There are basically two options if you want to pull equity out of your home. The first is a cash out refinance loan. With this you are often limited to 75 or 80% of the appraised value on an investment property and possibly slightly higher on a primary residence. This option provides the security of a fixed rate, but also tacks on closing costs, fees and a new set of prepaid escrow amounts. Depending on the loan amount and specifics you can quickly add thousands of dollars to the loan, reducing your expected cash out amount. With a HELOC there are often no fees, closing costs or prepaid taxes. There is a small annual fee to keep the line open, but whatever your cash out expectation is you will receive the entire amount. Not having to pay a whole new set of fees is very appealing.
- Blank Checkbook. You only repay your line of credit the amount that you use. If your line is $50,000 and you don’t draw from it, you don’t have a monthly payment. This gives you the security of knowing the funds are available, without having the monthly obligation. You can pick and choose your spots of when you want to use it, without feeling the pressure of a large monthly obligation. The downside of this is that you need to fight the temptation to use it for other things. A few hundred here and a thousand or so there will quickly add up and eat up your available funds.
A HELOC doesn’t always make sense for every investor or in every scenario. However, if you own a property you should at least explore the option, run the numbers and see if it makes sense for you.