How to Invest Using Your Home and Understanding the HELOC
By Christopher Levarek
“90% of all Millionaires become so through owning REAL ESTATE. More money has been made in real estate than in all industrial investments combined. The wise young man or wage earner of today invests his money in real estate.”
- Andrew Carnegie
What is a HELOC?
The Home Equity Line of Credit or HELOC is a powerful tool allowing an investor to utilize the present equity in an owned home of residence or residential investment property for purchases towards additional properties, renovations or other purposes. This credit line option is available at a wide variety of banks and credit unions in a variety of formats. Typically, a home owner must have a certain amount of equity, the difference between the current value and the owed mortgage/amount, to qualify for a HELOC.
Acting similar to a credit card, the HELOC owner can draw upon the funds in the HELOC for near any use and only would pay interest while there is a balance on the line of credit. If no purchases are made or there is no owed amount, no payments are made. This can be highly beneficial as it allows the owner to utilize the money when needed and unlike a Home Equity Loan, only pay interest if funds are drawn.
How Does it Work?
To qualify for a HELOC, a person needs to own a home or residential investment property and have equity within the property. Typically, banks or credit unions will only provide an amount available in the HELOC at a percentage of the total equity, commonly anywhere from 60-100% of the total equity. Below we demonstrate an example property and the amount of funds which would be available in a HELOC for a owner to utilize depending on the financial institution providing the line of credit.
Example HELOC Scenario:
Meet Bob. Bob owns a home and is looking into opening a HELOC for investing:
Bob’s Home of Residence - Current Value: $300,000
Bob’s Mortgage - Current Balance Due: $200,000
Bob’s Equity in Home of Residence: $100,000
Bob’s Bank’s HELOC Terms: 70%LTV(Loan To Value), 6% variable interest, 20 year term
Bob’s Possible HELOC Fund with his Bank: 70% (LTV Ratio) x $100,000 (Equity) = $70,000
In the above scenario, Bob would be able to tap into $70,000 of equity in his home for investment purposes. Bob could partner with others to buy real estate, invest in a large syndication deal or even purchase and renovate another property alone. In this case, the ideal investment to use with the HELOC should have a ROI(return on investment) greater than the 6% variable interest and/or allow Bob to increase his net worth, while progressing towards a long term financial goal.
Additional Things to Know:
Heloc Terms Vary:
Not all HELOCS are created equal and it is best to shop around to find the best HELOC terms for your needs. Lines of credit with higher LTV ratios, meaning a higher amount available for lending, will have higher interest rates as this represents more risk for the lender.
If the LTV was 100% in the previous scenario, Bob would have a HELOC at $100,000 of available funds however the interest rate could be around 8-9% as there is no remaining equity as a safeguard to the lender.
Variable Interest Rates:
HELOC’s will typically have variable interest rates meaning the interest rate will change with the current market and could rise or fall. This is good to be aware of as this could affect the success or profitability of a investment made with HELOC funds. Acquiring a HELOC with a fixed rates for X amount of years, a possible option, makes for a great investment fund on longer term projects.
Fixed Draw Period:
A HELOC will be given a 20 year loan term usually but funds will only be available to be “drawn” or used during the draw period which is usually the first 10 years of the term. This is done so the remaining term one is more inclined to pay off the balance versus increase the balance.
2nd Lienholder:
The provider or lender of the HELOC will take 2nd position on the home or property. If there is an existing mortgage on the property, this mortgage lender takes 1st position and the HELOC provider then takes 2nd position. This means on the current insurance and title, the HELOC lender will be added as they are given the guarantee of the “equity” on the property in return for the loan. If you sell the property, it will be required to pay off the 1st and 2nd lienholders with the sale of the property.
In Final
The HELOC is a great tool for using previously unavailable equity on a home or investment property to invest today. By investing today, a person can tap into the numerous benefits with owning real estate over time to include property appreciation, tax depreciation benefits, income from tenants and equity pay down on another property by tenants. Check out this Bigger Pockets video for more on investing using a Heloc. As always, Invest Smart!