Using a HELOC as downpayment

Question

My wife and I bought a fourplex in Los Angeles a year ago. It has been a good experience, and we would like to buy a second investment property, but we don't have enough cash for a decent downpayment.

We have about 21% equity in the house, and prices in the area have increased substantially. I've been thinking about taking out a HELOC, and using that as a downpayment.

I estimate the mortgage payments to increase by about $300, but the second 3-plex or 4-plex would cashflow about $1200-$1500. Plus another ~$800 in equity.

Any comments about this strategy?

Answer 1

Pretty sound strategy. The only pitfall is that with 21% equity (i.e.: 79% loan to value) you might not get any HELOC approved. From my experience the highest LTV they allow is 75-80%, so you need to check that.

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As @JAGAnalyst pointed out, and I missed, you're actually planning to use the HELOC as downpayment, and not as a cash for cash purchase. That will leave you with a fully leveraged property that you'll have to pay loans and expenses for while it may not be rented.

I suggest you reconsider your cashflow calculations for less than optimal scenario. Consider your property rented 75% of the time on average, and recalculate everything. Also consider the peaks (the time when your property is vacant) and whether you can sustain them for long periods (remember - 75% average).

If your cashflow is still going to be positive - then it is an option worth exploring. Do include all the expenses in the calculation: debt, maintenance, taxes, insurance, utilities, service providers (gardener, manager, HOA, etc).

Answer 2

I would have some concerns about this strategy.

Perhaps your experience is different, but the landlords I know who've done well and still enjoy being a landlords typically tried to pay of one property at a time. Then, they were able to use 100% of their net cash flow from the paid-off properties (since they didn't have a mortgage anymore) to purchase their next property.

My main concern for you would be that you would be adding debt without adding any additional equity. I would also suggest that you won't actually be increasing your net cash flow by much, since most of the new revenue from the second property will be going to pay the additional HELOC payment as well as the second mortgage on the new property, since you are only paying a down payment. You would be in control of more property, but not much more profit. In fact, if you have trouble with the property values, or getting tenants who pay on time, or vacancy, you could have additional problems.

I would also be concerned that if anything happens to your main source of income, you'd be at greater risk since you would now be carrying more debt. If I were you, I'd focus on paying down the first mortgage so that more free cash flow becomes available for additional properties. If I couldn't put together a proper down payment from cash rather than additional debt, that would be a sign to me that it may not be the right time to take on more debt.

I know this isn't the conventional wisdom, but just my two cents. Good luck!

Answer 3

I am in the process of using my HELOC for a down payment. I have done very well with the 3 rental properties I already own. I think discipline is the key. I plan on using all of my profit to pay back my HELOC before I ever see a dime for myself. I also mortgage all of my rental props. The principal is very low on all three. It's taxes and insurance that are the killer for me.

Answer 4

Terribly risky and asking for trouble IMHO. While leverage increases your potential profit, it also increases the magnitude of your mistakes.