The HELOC Plan

 

At one of the REIG (Real Estate Investor Group) meetings which I still attend, I was talking with one of the members about alternative financing. He mentioned that one of the other members had a program that I might interest me. So I decided to speak to the member, who I'll call Banker John. And after our conversation, I was confident that I had found the way to finally win at real estate. This is the HELOC plan.

The idea is this: first, you pay off your most valuable property. Next, you put a HELOC (home equity line of credit) on the property. Now you can literally buy properties in cash, within your HELOC limit. Once it's purchased (and rehabbed if needed), you do a cash-out refinance on the purchased property, using the proceeds to pay back the HELOC. With the HELOC balance paid off, you now have two properties and the money to buy the next one. 

I just read the explanation back and it sounds a bit confusing, so maybe an example works.

My most valuable property is Property 5, a four unit with a finished attic apartment in which I live. I owe about 72K on the mortgage, and the property is worth about 250K. The first step would be to pay off the 72K so that I would own the property outright. With the property fully mine, I can now put a HELOC on the property with an 80% LTV (80 percent of Property 5's value), giving me access to 200K. With me so far?

Now, let's say I see a property for sale that costs 150K that needs around 30K worth of repairs to increase it's value to 230k. I can use my HELOC money to make a cash offer, pay the closing costs, and do the repairs. Once it's finished, I can either sell or refinance the property to pay back the HELOC. With the 200K paid back to the HELOC and whatever profits I've gained, I can repeat this process over and over again. No more loan applications. No more long processes. I can literally turn my most valuable property into my personal bank to make cash offers, then buy, fix, and sell (or refinance if the numbers work). 

 

Last year, my insurance company forced me to fix my roof and pave my driveway, increasing the value of the property but also increasing my monthly payments dramatically. I had to use my Business Line of Credit to pay for it, and now I have a $500 per month bill that I have to pay along with the increased monthly mortgage payment. The city made more money taxing the increased value of the property. The insurance company made money. The roofers made money. The insurance company made money. Everybody made profit from that situation except for me. It's nice to know that I can finally benefit from the increase in property value. But, as with all things, there are downsides.

The biggest issue is the rising costs of available property. When I first came to Smalltown 20 years ago, 200K would be enough to buy 2 multi-family properties. Now, 200K is just below the average cost for a decent property. This means that I'll have to stick to fixer-uppers until I can add enough profit to buy more expensive properties.

The next issue is also cost related... rents. The current standard for rents in a decent neighborhood in Smalltown is as follows:

Studio - $850

1 Bedroom - $950

2 Bedroom - $1,300 (House - $1,600+)

3 Bedroom - $1,800 (House - $2,000+)

If a single family 3 bdrm house now goes for $250K, the monthly mortgage would be around $2,200 - $2,700. Just to break even, the rent would have to be at $2,700, which is pretty high for Smalltown. Can I attract such tenants and, even if I could, is it worth it? And we haven't even discussed the maintenance costs yet!

So clearly there are advantages and disadvantages to this strategy, but one far outweighs the other. The HELOC plan is the way to go for me. No more needing to answer questions about whether the prospective property meets certain loan criteria and all that crap. All I have to do is find the property, and I'll have an immediate advantage over financed buyers with my ability to make cash offers. And the largest "pro" is the concept: I can acquire property easier and faster. It's combining my seemingly successful strategy for picking good tenants and good properties with an easier way to acquire these properties. On paper, this looks risky but very promising.

Once I start the application process Banker John's HELOC, I'll make a more detailed post which will include terms, interest rate, and all the specifics. This post is all about getting myself hyped, and it's definitely doing its job right now.

 

P.S.: One thing I forgot to mention is that I have experience with these type of refinancing deals. Explained in a post almost 8 years ago, I bought Property 5 by refinancing Property 4, which I owned outright at the time. I then used the profits from Property 4's refinance as a down-payment to purchase Property 5. It turned out to be a great deal then, and now I can do it again. And again. And again.