Is a Home Equity Line of Credit (HELOC) or a Cash Out Refinance Better?

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A cash out refinance can allow you to take cash out of your home with a long-term mortgage. A home equity line of credit (HELOC) allows a homeowner to take money out with a short-term loan. A home equity line of credit (HELOC) gives someone more flexibility on how much money they take out and when they take it out, but the line can have shorter terms and higher rates. I own 16 rental properties and I complete 10-15 fix and flips a year. I have used both a cash-out refinance and a HELOC, and I will detail the advantages and disadvantages of each in this article.

For more information on my rental properties and my investing strategy check out my complete guide to purchasing long-term rentals.

What does it mean when you refinance your home?

When you refinance your house, you are getting a new loan that replaces any current loans you have. Many people will refinance to get a lower interest rate, to decrease their payments, or to take cash out of the home. Refinancing your house is very similar to getting a loan when you first buy the home. You must qualify for the loan based on credit, income, time at your job, and more. The loans terms can be 30 years, 15 years, or less depending on the borrower’s needs. Interest rates and loan costs will be very similar if not the same as a loan when you buy a house.

When you take out cash while refinancing your loan it is called a cash out refinance. To complete a cash out refinance you must have a certain amount of equity in the home to get a bigger loan that what you currently owe on the house. Since the balance on the new loan is higher than your old loan, you receive cash at closing. You still have to pay closing costs, which may include an appraisal, loan origination fee, recording fees and more. Those closing costs will decrease the amount of cash that you are getting out of the refinance.

Here is an article with much more information on a cash out refinance.

What is a Home Equity Line of Credit (HELOC)?

A HELOC is much different from a refinance, because you may not have to pay off your current loan. If you have a $100,000 loan on your house, but your home is worth $200,000 you may be able to get an $80,000 line of credit and keep the $100,000 loan in place. When you take out a line of credit you do not have to use the money right away or ever. You can use as much of the money as you want and pay it back when you like. You can borrow the money again after you pay back the line. A refinance is a mortgage where once you pay off the loan or pay extra money into it, you cannot borrow it again.

A HELOC will have closing costs like a cash out refinance, but many times they will be less. Depending on if you are getting a line on an investment property or a personal residence the terms and fees will differ. The term of the HELOC could be two years, five years or longer, but not 30 years like a refinance could be. The rates on a HELOC are also usually higher and can go up or down as interest rates go up or down.

Here is an article with much more information on HELOCs.

How have I used a cash out refinance on my rental properties?

I have refinanced two of my rental properties. Rental property number 2 and rental property number 3 were refinanced and I was able to take cash out on both properties. I was hoping to take out more, but I was able to take out over $25,000 on each rental properties.

When I refinanced those properties, my biggest obstacle to buying more rental properties and reaching my goal to buy 100 rentals, was finding the money for down payments. When I refinanced those properties it gave me the money to buy one more rental from each refinance. The refinance did increase my mortgage payments slightly on those rental properties, but interest rates are so low that I was still able to have great cash flow after the refinance. It helps to buy properties below market value to get great cash flow and have enough equity to refinance.

My portfolio lender will refinance 75 percent of the value of the home based on an appraisal or a desktop valuation on investment properties. They will refinance with a higher loan to value ratio on your personal residence. You may find that conventional lenders are much less likely to offer a cash out refinance option on investment properties.

For more information on financing long-term rental properties, fix and flips or owner occupant homes, check out my book: Build a Rental Property Empire: the no-nonsense book on finding deals, financing the right way, and managing wisely. 

How I have used a HELOC on my rental properties

I recently paid off my first rental property. This was very exciting for me and provided increased cash flow as well as financing opportunities. I was able to get a HELOC on that property about a month ago. Since this was an investment property, my portfolio lender charges me a 1 percent origination fee and had an appraisal done to determine my line of credit.

The appraisal came in at $160,000 and my lender allows a 75 percent loan to value on investment property lines of credit. On a personal residence they go up to 90 percent loan to value on a HELOC. I was able to get a line for $120,000, and at the time I had no idea how I would use the line.

How the HELOC helped my fix and flip business

My fix and flip business has taken off lately. I own 8 fix and flips and I am buying a 9th in June. Fix and flips take a lot of money to complete, especially with my financing which is 75 percent of the purchase price. I have to use my money for down payments and repairs.

On one of the fix and flips I recently bought, I made an offer with cash. I still get a loan on these properties, but have no appraisal or loan conditions and can close in 15 days. Even though getting a loan does not affect the seller at all, the sellers (a REO property) required me to pay cash and lot use a loan at closing. I have never had this happen before, but if I wanted the house I needed to pay cash.

With so many fix and flips going I did not have the cash available to buy that home, but I had my line of credit available. I took out the money from my HELOC and paid cash for the home. I was then able to refinance that fix and flip to free up more money a couple of weeks after closing.

When is a HELOC better than a cash out refinance?

A HELOC has many advantages over a cash out refinance. With a HELOC you do not have to take out the full loan amount like you do with a refinance. This allows you to have the option of taking out the money at some point in the future if you don’t need it now. You can also pay back the money from a HELOC at any time and then take it out again at any time. With a refinance once you pay back part or all the loan, you cannot take that money back out of the loan again without completing another refinance.

If you have a loan in place on a house and have a lot of equity in the home, you can get a line of credit without paying off the loan. The HELOC can be placed in second position and the first loan can stay in first position. When you refinance a home, you usually have to refinance any loans on the home as well.

If you think you may need money in the future for your business or rental properties, but you won’t need the money long-term a HELOC may be perfect. If you need long-term money for financing rental property down payments than a cash out refinance may be the better option.

When is a cash out refinance better than a HELOC?

A cash out refinance is much more long-term than a HELOC.  I used my cash out refinances to fund the down payments for more rental properties. I knew I did not want to pay back this money any time soon so a cash out refinance was perfect for me. If you need long-term money, a cash out refinance may be the better option than a HELOC. You will be paying interest on the money you take out in a cash out refinance so it is smart to put it to use right away.

Conclusion

Both a cash out refinance and HELOC can offer great opportunities to real estate investors. Many times a real estate investor’s biggest challenge is finding enough money to fund deals. Both a HELOC and cash out refinance can help to provide funds and let investors buy more properties and make more money.

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