HELOC as down payment for rental?

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UpwardTrend
Posts: 13
Joined: Sun May 20, 2018 8:05 pm

HELOC as down payment for rental?

Post by UpwardTrend »

I am considering buying (another-ish) rental.

We own one primary residence, and one vacation home that also rents out some. I just bought the vacation home one year ago, so haven’t done my taxes for the year to see how it shakes out, but we feel very good about this because we’ve been able to use it and also cover almost all of the mortgage with rents. Win/win.

I live in a HCOL area. New rental would cost 380-400K and I’d put 25% down. I have the cash to put down the 25% but it would deplete my emergency fund. But I also have a 190K HELOC with a zero balance that I could draw from. The thought in using the HELOC is that the rate is Prime - 1% (which means 2.25% for now, but could of course go up to 3.25 - 3.75% as The Fed does their thing this year.)

My income is sufficient to carry this mortgage should it not rent right away, or to cover gaps in tenants (very rate in my market) or for repairs. I’d make about $500 in net income from the rental. Appreciation is steady over the past 2 decades and should continue to be solid going forward.

The plan would be to use the HELOC as a down payment (roughly 100K) and then pay it down over the next 10-12 months with my W2 income. I have a good bit of overage each month after maxing out 401k and my deferred comp plan. In 2021 I was putting 10K each month into Vanguard brokerage, but could shift that for the next year to paying down the HELOC, or do a hybrid of half Vanguard/half HELOC.

Thoughts? Do I have blind spots? Thanks.
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David Jay
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Location: Michigan

Re: HELOC as down payment for rental?

Post by David Jay »

Why pay interest on the HELOC when you can use the emergency fund at lower cost (assuming it is in liquid assets, which it should be if it is an emergency fund)? Makes no sense to me.

If you have a $190K HELOC and have an emergency, that is when borrow from the HELOC. And you will be rebuilding the emergency fund over 10-12 months anyway.

BTW - I used a HELOC as my emergency fund for my last few working years.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
jbinpa59
Posts: 150
Joined: Wed Jul 10, 2019 3:29 pm

Re: HELOC as down payment for rental?

Post by jbinpa59 »

David Jay wrote: Thu Jan 27, 2022 8:07 pm Why pay interest on the HELOC when you can use the emergency fund at lower cost (assuming it is in liquid assets, which it should be if it is an emergency fund)? Makes no sense to me.

If you have a $190K HELOC and have an emergency, that is when borrow from the HELOC. And you will be rebuilding the emergency fund over 10-12 months anyway.

BTW - I used a HELOC as my emergency fund for my last few working years.
Davis Jay "s suggestion makes more sense to me
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Harry Livermore
Posts: 1937
Joined: Thu Apr 04, 2019 5:32 am

Re: HELOC as down payment for rental?

Post by Harry Livermore »

I think you could either use the HELOC or your EF with no great harm. I'd be tempted to use the HELOC. Just my preference. Shunt new money into paying that down.
Unrelated questions and comments, feel free to ignore... you did not ask our opinion on the overall idea:
Do you have a mortgage on your residence? Just curious. We have a house, a SFH rental, and a vacation rental. We bought the vacation rental for cash; no way would I have bought the vacation rental with a mortgage... 2 is enough juggling for me. But I understand other folks can handle complexity and juggling better than I can. If you suffer a job loss with 3 mortgages, how long can you tread water without serious, long term harm to your financial life?
You don't say where you are but I presume we are at an all-time high in terms of property valuations. No one can predict the future, of course, but we have been lucky with each property purchase in that it was in, or near, and all-time low. It seems to me, folks buying now will have paid a small premium at the very least. Of course, we don't know the future.
$500/mo net seems a little low to take on a lot of risk. But maybe you need an asset that spins off cash flow without limiting final principal value. $500/ month free cash flow (possibly tax free) is nothing to sneeze at. But if you spend 10 hours per month over at the rental, is it really free, or have you taken on a $50/ hour job with capital risk?
To understand my perspective, here's the gist of the strategy on our SFH... tax-free income during our biggest spending years, from an asset we already had (we had lived there for 17 years prior to converting it to a rental) Our SFH runs a tax "loss" every year with depreciation (our AGI is usually too high to take it, so it's mostly been piling up as a carry forward) But I (like you) can pay the mortgage from my income. So it's been tax-free income that goes straight into a savings account, and from there, variously deployed to kids' 529s. Our oldest is finished with undergrad, and our daughter's projected college costs are in the bag, with our youngest's mostly in the bag. Since it's sort of mission accomplished, and we are older, AND property values seem to still be in the stratosphere, for us it is a tempting proposition to sell. For 11 years, tenants have provided us with college funds for the kids, while allowing our asset to grow. But it may be time to simplify.
You don't say how old you are or where you are in your life cycle, so I'm just spitballing...
As I said, feel free to ignore.
Cheers
Topic Author
UpwardTrend
Posts: 13
Joined: Sun May 20, 2018 8:05 pm

Re: HELOC as down payment for rental?

Post by UpwardTrend »

Thanks for the responses.

We are 48 and probably 7-10 years from our ideal FIRE number, so I’m still in the accumulation phase. We have two middle school ages kids. No debt except for the 2 mortgages: One on our primary, approximately 56% Loan-to-Value, but that is also the home with the 190K HELOC, for a total of 77% combined LTV if fully drawn. And one on our vacation rental, which is in a major ski resort/mountain area and could more than pay for itself if I choose to rent it out all year long.

Buying a rental is part of my desire for multiple streams of income and diversification down the road, and I live in one of the strongest real estate markets in the country. The tax benefits are especially appealing, and the thought of carrying 3 mortgages and being a landlord does not intimidate us at all. I have a spouse that is not currently working (by choice) but could go back to the Operating Room as a RN if desired or needed. With my busy career and kids that are still younger, we’ve chosen to have a point person at home which has been invaluable. I hope that college will be fully funded by the time they get there, but if not we could always sell the rental (and pay the appropriate taxes if needed.)

I hadn’t even considered the tax loss carry-forward rules, but I’d be in the same boat as you, Harry. Thanks for bringing that up.

Good points about using the emergency fund instead of the HELOC. For some reason using the HELOC just feels better, even though I realize I’m paying interest just for the sake of “feeling better.”
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