There are a lot of questions about the use of Cash-out refi versus HELOC in a real estate investment and which one is better or easier to get. We are here to help you answer some of the most important questions.
It all depends on what you’re trying to achieve. It also depends on what you’re more comfortable with using as a collateral. On the Cash-out refi side, what you use as a collateral is any property you have.
It could be your home. It could be your rental. It’s any property. When it comes to a HELOC, it’s a Home Equity Line of Credit. What does that mean?
What’s a HELOC?
It means that in order for you to be able to take money out using a HELOC, you are actually using your own home. You have to use your home. Not a lot of people are actually comfortable using their own home as a collateral because that means, what if you default on a payment? You can actually lose your home. You have more skin in the game on this one. You may be working really hard to acquire that rental but you might be okay at the end of the day because you still have a home.
That’s number one. The second one is, with a cash-out refi, you get a lump sum out of it. It’s like a mortgage that you’re actually putting in. You put your house or your property as a collateral. Then all of a sudden, they give you $200,000 right from the get-go. You have $200,000 that you are responsible for repaying and the payments are due immediately the following month. If you were to use a HELOC, it works like a credit card. Let’s say the bank gives you a line for $200,000 but you don’t have to use all $200,000.
It’s literally like a credit card, only it’s backed against your home. Now, you have $200,000. Let’s say this month, you wanted to use $40,000 out of it. You use $40,000 because you saw a house that works out. You take $40,000 out. Then you put that money as a down payment for your investment property. You let it go for a couple of months, but in the meantime, you’re only responsible for repaying $40,000. Again, it goes down to, it all depends what you’re more comfortable with. Do you want to be responsible for repaying $40,000 only or do you want to be responsible for repaying $200,000 all in one lump sum?
You have the cash readily available. First, it’s available on paper but you still have to take it out. Second, the interests are very variable. For example, with a cash-out refi, you get a fixed rate. It’s literally like a mortgage. It’s fixed for the entire 30 years or 15 years, whatever your term is. The interest rates on the HELOC are variable. It’s like a credit card. It varies depending on the market. If the Fed comes in and says, “You know what? We’re raising interest again this quarter.”
Guess what’s going to happen to your interest? It’s going to go up according to the market. It’s the same thing with the credit cards. You’ve probably seen it before. You have a credit card that you got approved and all of a sudden, the Fed announces something. You get a letter in the mail saying, “Well, because the prime rate went up by this much, we have to increase your interest rates by a certain percent.” The same thing happens when the interest rates go down. They could lower your interest rates but they don’t necessarily do it.
You actually have to call the bank and ask them to lower the interest rates. You have no control so to speak over the interest because it changes depending on what the market dictates. The good side of it is that you’re not responsible for a big chunk but you still have access to the capital.
What the Market dictates on a Real Estate Investment
If for whatever reason the market changes, the new amount you are taking out from your HELOC is also subject to the new interest rate. Again, completely up to you as to what you prefer. Now, the next thing is how much of an LTV you get. Typically, with a cash-out refi, you will get a 75 LTV. Meaning, you have to put 25% down. You can do a cash-out refi on any property. It can be on a rental or it can be in your own home.
That’s why in order to force you to have more skin in the game, you’re going to have to put more money down because, otherwise, you wouldn’t walk out of it so easily. That’s why they no longer do 100% finance because if it doesn’t work out, then you can just simply walk out of it.
In essence, it depends on what you’re looking for. Do you want more money out of that one property? If so, are you willing to put your home for it or are you okay with getting a 5% less on that cash but you’re putting a rental and not your home in particular?
Cash-out Refi Vs. HELOC: The Fees
Then the next thing that you have to consider is the fees. Guess what you’re going to have in a cash-out refi? You’re going to have mortgage origination fees. You’re also going to have closing fees. You’re going to have to add something between 1% to 6% on fees that you’re going to get out of it. On HELOC, since it is treated like a credit card, there might not be application fees or closing costs but you will have to pay fees.
It’s kind of like a credit card, a membership fee, a maintenance fee, a processing fee every time you take money out of it. These are also some of the fees that you might want to take into account. How often are you going to take money out of this HELOC? Because every time you pull money out, there’s a fee that you’re going to have to be responsible for. Because it runs like a credit card, you also have to worry about keeping it active.
If you don’t keep your HELOC active, the bank could either lower your credit limit which hurts your credit or they could cancel it because it has been out of use for the last two years or so. If you don’t use it, you lose it. You have to take some money out of it whatsoever. You can’t just simply have a HELOC for $200,000 and never use it. You have to take money somewhere along in the equation, just so they can see that there’s action that is happening.
You don’t want to go through this whole process of paying fees, application fees, and then have them take it away from you because you’re not using it. On the Cash-out Refi, since it’s fixed, it acts like a mortgage. You have that account open for some time between 15 or 30 credits but then you have a lump sum.
Would you be responsible enough to be able to manage that lump sum and invest it in something that’s going to give you cashback? That’s basically what it comes down to. Getting one option or the other depends on a lot of factors. It depends on your credit.
It depends on your debt-to-income ratio. For example, getting a HELOC should be easier but, even though it’s your home, you might have such a low credit or such a high debt-to-income ratio that the banks might not be willing to lend you anything. The person who has a much better credit and a much favorable debt-to-income ratio has better chances of getting it.
Whether you get approved for a cash-out refi or for a HELOC, it all depends on your profile; how high your credit is, how responsible you are with money, how high or low is your debt-to-income ratio and all of that plays into the deciding factor or the deciding formula. The lenders have to decide whether you get the money or not.
The last factor in a Real Estate Investment: Time
The last factor to consider would be time. What’s the timeline? Typically, when you have your own home because they already know this is your home, you can actually get a HELOC right away. You can close on a home, let’s say last month. All of a sudden, you realize how much you want to take out. Then you can actually apply for a HELOC right away versus a cash-out refi that you have to let the home season with you. If you recently bought a home, some banks require that you own it for six months.
Some require that you have owned the home for at least 12 months. The seasoning plays a big factor. You have to hold the home long enough in order to have enough equity for you to be able to go to the bank and request some capital but how much equity do you think you can possibly include or bring up as soon as you buy a home? If you bought a home last month, chances are you haven’t even made your first mortgage payment, which means all you have left was the 20% or the 5% that you put into equity and most lenders require you to have at least 20% equity so they’re willing to lend you against 80% of what you owe.
A renovation will probably take you at least two to three months to do. Even if you wanted to take a HELOC a month after you close on your own home, you still cannot because you’re waiting to force the appreciation up in order to bring the value of the house up so you can take a HELOC out of it. Maybe you can get a couple of thousands more. If you’ve been holding a home under your name or under your LLC name for 6 to 12 months, you will most likely have accumulated enough equity over this period of time and then if you decide to make some cosmetic upgrades, that’s different from having to renovate.
If you make cosmetic upgrades, you can still force the appreciation. That doesn’t mean you’ll have to tear the entire house apart and flip it around. By changing door knobs, maybe window accents, maybe fixing the water heater like putting a new water heater in there, that will automatically bring the value of the home up because you’re having newer appliances. Last but not least, for HELOC, you do not need an LLC because why would you have your own home under an LLC and on cash-out refi, you can either close it under your name or depending on the bank, if you’re doing a commercial mortgage, most likely, the requirement is that you do the closing on LLC.
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