So you’re FINALLY ready to start investing in real estate. You’ve been kicking the idea around for awhile and, now, you’re feeling good — no more fear or self-doubt holding you back. Next step: that first great deal and, from there, the financial freedom you’ve always craved.
It’s an exciting moment. And, if you keep pushing and keep moving the ball forward, it’s a moment that will define your personal and professional life forever. This is the moment you took charge. This is the moment you dove in and carved an incredible path for yourself and your family.
But then…you hit your first speed bump. I won’t call it a challenge or a hurdle, even, because this is one you can push through. With a little perseverance and a head-down, must succeed attitude, you’ll plow through this bump in the road.
That bump? MONEY.
While we always talk about real estate investing with no cash, the fact is you’ll need some money to make money in this industry. It just doesn’t have to be your money.
We’ve talked a lot about the different funding sources for real estate investors, from private money and hard money to alternative methods for buying properties. But what if those don’t make sense? What if you don’t quite have the pieces in place to pitch a hard money lender on your latest deal? If you’ve tapped every private money source in your arsenal? When the clock is ticking and you’re still coming up empty?
Here’s what you don’t do — you don’t walk away from the deal. You DO get creative and keep looking. There are endless funding sources and, chances are, you’re sitting on one right now.
You’re Sitting On Your Next Funding Source Right Now
What am I talking about? Your home. If you own a home — a house, an apartment, a condo, a unit you rent out — you have equity in that property. A home equity line of credit (HELOC) looks at your equity and, based on where it stands at that moment in time, issues a second lien on the property. In other words, you have two mortgages — or, more specifically, a first mortgage and a second line of credit — on one house.
The process of securing a HELOC is similar to getting a mortgage on a primary residence. You’ll fill out the application, provide various financial documents and wait for the underwriter to sign off.
If you’ve been a responsible borrower and have a strong credit score, you’ll likely want to reach out to your existing mortgage lender first. Based on your credit history and history with the lender, you’ll likely be able to lock down a good deal on a HELOC — more favorable terms and an easier underwriting process, for starters. If you opt not to go that route, virtually every big bank and major lender offers HELOCs. You can even tap a mortgage broker if you need a little more help or have some rough patches in your credit history.
The PROS of Using a HELOC
Many real estate investors turn to HELOCs because, for starters, they tend to come with lower rates and more favorable repayment terms than hard money. HELOCs are typically based on the prime rate which, right now, is very buyer-friendly. While rates are adjustable, this doesn’t usually impact real estate investors who flip properties before any shifts go into effect.
In that vein, most HELOCs come with the option to pay interest-only for the first 10 years of the loan. Again, because you’ll be flipping the property within a few months, most likely, you’ll be able to make interest-only payments — very low interest-only payments — for the “life” of your loan. Just be sure you aren’t subject to any pre-payment penalties — you don’t want a HELOC looming for years or even decades when you’re flipping the property in six months.
HELOCs also come with a tremendous amount of flexibility. You may take out a $100,000 HELOC on your home, but only use $25,000 for your next deal. In that case, you’ll only be making payments on the $25,000. But, you’ll still have a $75,000 line of credit kicking around if you need anything else.
Another pro? HELOCs don’t have to be used to buy the property itself, like other financing often does. Because of this, HELOCs are great go-to sources if you need money to tackle renovations and rehab work, market your property or to invest in anything your latest deal needs. While a private or hard money lender may fork over cash for this kind of work, many times they won’t — often their only concern is closing the actual deal on the table, not everything (or anything, really) that comes after.
Because HELOCs are tied to your equity, you can dictate how they’re used. So even if you’ve secured funding for the deal itself through another source, you may consider tapping a HELOC to fund everything that comes next. If you don’t have the cash on hand to get these critical pieces done, a HELOC can be a total deal-saver. And even if you do, you may opt to take out a HELOC to fund the rehab process — why tie up your savings if you don’t have to?
What to Know BEFORE Taking Out a HELOC
While there are plenty of perks to using a HELOC for your next investment, it’s also important to keep some of the drawbacks in mind. One issue I’ve seen is that many first-time investors get too reliant on their HELOC. I get it — it’s like a windfall of cash!
Since there’s lots of flexibility, it’s easy to start turning to a HELOC balance for anything and everything. So, for example, an investor may get a $75,000 HELOC with the intent of investing in new properties. But things happen — life happens. And a few thousand dollars winds up being allocated to business expenses, while other funds get spent on networking or travel. Before you know it, the HELOC is spent and you’ve got a huge debt against your business — a huge debt that isn’t being actively used to generate income. Not ideal.
My advice? Tap an accountant to help you manage your funds, including your HELOC. While they won’t necessarily say no to your asks — and, really, they can’t — they’ll be able to help guide you towards smarter funding sources and strategies for all of your business expenses. Having this kind of management-check in place may help deter you from overextending yourself and your HELOC.
It’s also important to remember that a HELOC reduces the equity you have in your home (or whatever property you leverage to get the HELOC). If your plan is to flip the property, pay back the HELOC and keep the extra for yourself and your business, great. If you’re planning to hang onto the cash and make minimum payments on your HELOC, you are eating into your equity — it’s not the worst thing in the world, but it is something to be aware of.
Done right, HELOCs are a great way to expand your portfolio and make your equity work harder. Your home equity isn’t doing much in its current state. Even if property values are rising, you’re likely only gaining a small percentage each year. Convert that equity into cash and use that cash to flip properties, and you’re earning a massive return. I know what I’d prefer…
We’ll dig into HELOCs and other traditional and nontraditional funding sources at the Nick Vertucci Real Estate Academy. It’s a key piece of the business — remember, find, FUND and flip! — and we spend tons of time going through all the ins, outs, pros and cons. So get registered and come with questions. Can’t make it to the Academy? NVREA is hosting lots of seminars and workshops around the country. Check out my site to see when we’ll be in your area next.