How to Use Home Equity to Buy Your Next Rental Property (3 Ways) (Rookie Reply)

Ashley Kehr:What if the money you need for your first rental property has been sitting in your home the entire time and you just didn’t know how to access it?

Tony Robinson:Today we’re answering three real questions from the BiggerPockets Forums that every Ricky eventually runs into. How to use your home equity to fund your first deal, how to use your first investment property’s equity to buy a second one, and the question that keeps lots of out- of-state investors up at night, do you self-manage from a distance or do you hand it out?

Ashley Kehr:This is The Real Estate Rookie Podcast. I’m Ashley Kerr.

Tony Robinson:And I’m Tony J. Robinson. And with that, let’s get into today’s first question. Our first question today comes from Michael in the BiggerPockets Forms. And Michael says, “A partner and I, both working full-time jobs, are looking to get into real estate investing. We’re focusing on long-term rentals for our first property. I’ve listened to plenty of podcasts and read a bunch of books, but only if you mentioned purchasing your first rental with a HELOC. We have cash available, but with a large amount of equity in our primary residences, we wanted to avoid tapping into that cash and instead take advantage of our equity. Would anyone be able to offer general advice on this approach? Any insights from those who have done it or from those who say don’t? Anything would be appreciated. First, Ash, I guess let’s just define what a HELOC is. So HELOC stands for home equity line of credit.So if you have equity in your home, let’s say that you have a home that’s worth $100,000. Your loan balance on that home is maybe $60,000. And let’s say that the bank will give you up to 80% loan to value on the HELOC. That means it’ll go up to 80% of $100,000 or $80,000. Minus your 60K that you owe, you have $20,000 in topical equity. So they’ll say, Hey, we’ll give you basically an open line of credit. Think of it. It operates almost like a credit card. We’ll give you an open line of credit for $20,000. And that is basically being backed by the equity that’s in your home. So if for whatever reason you don’t pay, they can put a lien on your house, they can take it, whatever it may be. But that’s what a HELOC is. It allows you to tap into your equity, but you only pay when you actually use it in the same way that a credit card would work.I have some thoughts on whether or not we should use HELOCs for just kind of traditional turnkey short-term or long-term rentals or short-term for that matter even. But Ash, I guess I’m curious for your thoughts first. What do you

Ashley Kehr:Think? I’ve only used lines of credits for short-term purposes. So knowing that I’ll be paying it back within a year, as in I’m usually using it to purchase a property and then I’m going to refinance and pay back the line of credit, or I’m going to use it for the rehab costs, and then I’m going to go and refinance and pay back the HELOC. So I definitely have heard people use it to pay for their down payment. And what they do is they take the cash flow from the property, take money from their W2, and they just bulk pay down the line of credit. What you also could do is run the numbers so that you have your mortgage payment, make sure the rent can cover your mortgage payment, and then say, “Okay, I’m going to pay down $500 of my line of credit every single month and make sure that the cashflow will cover both of those monthly payments.” So even though on a HELOC, most of the time it’s interest only payments that the bank charges you for so long, you could put your own plan in place knowing that over the next five years, I’m going to pay X amount every month and I’m going to know that I still will cash flow on this property and that the line of credit will be paid off within X amount of time from the property and the numbers support that.I’m not a huge fan of getting the line of credit to fund a down payment without any kind of plan of really being able to pay it back if you’re waiting a long time to pay it back. I think it’s more of a short-term debt play. And I think some line of credits. Tony, I think last time we talked, you were looking at a line of credit for your house and it was like after so many years it would actually convert into amortization where they’re including principal now into the payment instead of just interest only. But if you look at the debt, that’s a lot of interest you’d be paying over 10, 15 years because usually you’re not getting as good of an interest rate on a line of credit and you’re paying interest on whatever the principal isn’t paying down. So make sure you have a plan to at least start paying down principle.

Tony Robinson:Yeah, Ash, I agree completely. I think that using a HELOC in a short-term scenario at least would allow me to sleep a little bit better at night. And I think the benefit though of the HELOC is that you get to keep some of that liquid cash for a rainy day, but there are also some things to consider with the HELOC as well. One of the points being that the interest rate on a HELOC is not fixed. It’s usually tied to the prime rate and there’s some kind of premium on top of that. So let’s say that prime is whatever, 4.89, then they’re going to charge you maybe a point higher than that. So you’re at almost 6% of your interest rate, right? But if prime goes way up, then the cost on that line will also go up as well. And what you’re paying to maintain that line will go up.So knowing that it’s not a fixed interest rate over the life of that line is something to account for. So maybe model it like, “Hey, what if rates go up by 2%? Can I still afford to pay both whatever deal I’m taking down and the cost associated with this line?” Sorry, I just been fighting a cold.So I think that’s one thing to consider is the variability of the line. And if rates swing, can you still afford it? The other piece too is that the lines of credit still do impact your ability to get approved for another loan as well. So if you’ve got this big line and you’ve pulled a lot of debt, well, now does that impact your ability to actually go out there and get approved for the mortgage on the property and what does that look like? Again, I think that’s where using it in a short-term basis maybe makes a little bit more sense. I think that the ideal scenario for me is exactly what Ash laid out. I’m maybe combining my HELOC with some sort of private money or maybe hard money into a property where I can go in, increase the value through some sort of renovation, and then I’m quickly paying that loan back either through a refinance or a sale of that property.But I think just dropping it in as a down payment on a property that’s going to take you 15 years to pay back, I’m not as crazy about that because it just puts a little bit too much risk for my appetite.

Ashley Kehr:Oh, one thing I’ll add too is to watch for, talk to small local banks or credit unions a lot of, and I don’t, maybe nationwide banks do this too, but a lot of them will have interest rate bonus. I can’t think of what they call it, but for the first read of six months, they’ll only charge you 3% interest on whatever you’re using off the line of credit. This can be really great if you’re just using it to fund a rehab and you open the line and you fund the rehab over three months and then you’re paying it back and you’re only paying 3% interest on that money that you use. That can be a really great tool. Coming up, so you’ve used your home equity to get into your first rental. Now that property is building its own equity. So how do you pull it out to fund the next deal?And what’s the difference between a cash out refi, a HELOC on the investment property, or just selling it? We’ll break it down right after this quick word from our sponsors. Okay, welcome back. So you’ve done it. You’ve got your first investment property. Now it’s sitting there building equity and you’re starting to think about deal number two, but how do you pull that equity out? Has major consequences for your cashflow, your taxes, and your flexibility going forward. So let’s look at the next question. This question comes from Xavier in the bigger pockets forums. “How can I access equity in one property to buy a second one? Should I sell, refinance, or use something else? I currently own a property that has around $110,000 in equity. My plan is to have a renter in by the end of the year. With this much equity, I’ve been thinking a lot about investing in a second property.What’s the best move? “Okay, so Tony, is this property a rental property or is this the one he’s living in right now?

Tony Robinson:He actually doesn’t specify. He does say my plan is to have a renter in by the end of the year. So maybe let’s just assume that this is someone’s primary residence that they’re looking to convert into a rental because I think they give us a little bit more options.

Ashley Kehr:Yeah. And I like that because I’m seriously struggling with the same issue right now. So this is even more great to talk about because I could share the conflict that’s going on in my head right now. But yes, there are these three paths and honestly there’s probably more paths and more things that you could do with it. But the first option looking at is the cash out refinance. So this is where you’re going and you’re going to go to the bank, get a new appraisal and say you have this much more equity than when you purchase it and we’ll give you a loan that’s maybe say $50,000 more than what your loan balance is today. Your payment’s going to change, your interest rate’s going to change, but you’re going to get that $50,000 check back to you. So then that’s where you can take that money and you can go ahead and purchase another property.What you have to look at when you’re considering a cash out refinance is you have to consider your interest rate and your payment. So how is that going to change how much the monthly mortgage payment is? So if say your mortgage payment is $1,000 per month right now and you’re going to go and you’re going to pull $50,000 out, maybe you had a nice 3% interest rate and now it’s going to jump to a 6% interest rate, plus you’re going to have a higher loan balance, but you amortize that over 30 years. Sometimes, like I just looked at an investment property that I bought 10 years ago, and if I were to pull out, I think it was the number was $80,000 right now and I restarted the amortization period, I would actually have the same exact payment because I’m restarting the amortization and it’s spread out.So there’s different things that even if though you’re taking out, getting money out, it could still end up your payment is the same. You’re just extending the life of the loan now. Car dealers like to do that trick. You go in, well, we’ll do a home warranty and it’s only going to raise your payment by two, or not a home warranty, a car warranty, but it’s only going to raise your payment by $6 a month. And then they’re kind of just weaseling in. It’s actually going to extend your monthly payments by six more payments or something like that. So those are things I would look at with a cash out refinance. And Tony, what about a HELOC?

Tony Robinson:Yeah. And let me just add to the cash out refi. I think one thing to consider, one thing that makes us trickier for a lot of people maybe in the time of this recording is that a lot of us have really low interest rates and a lot of properties that we’ve purchased in the last three to four years, or definitely coming out of COVID. And it does make the math a little bit more challenging on doing a cash out refinance because we’re replacing this maybe 3% or sometimes even sub 3% interest rate. Still, my best interest rate on a property is a 2.65% interest rate. I’m probably never going to do anything with that loan because 2.65% is such a low rate. So you do want to take into account and do the same math that Ashley did on, hey, if I do do this cash out refinance, what does that do to my payment?What does that do to my term, my amortization period? And just make sure you’re taken into account all of those different variables.For the HELOC, we just talked about what that is in the first question, so no need to rehash that, but just know that it is a little bit more difficult to get a HELOC on an investment property. A lot of banks and lenders will only want to work with you if you’re doing a HELOC on a primary residence. Though there are properties or there are banks that allow you to get HELOCs on investment properties as well. Actually, I’m working on a HELOC right now for my primary residence, and they told me that they actually do HELOCs on investment properties as well. So once I finish this HELOC on my primary, I’m going to look at, “Hey, can we get a HELOC on one of the properties that we bought earlier on in our career as well?” But the benefit of the HELOC is that it allows you to tap into your equity without impacting your current debt.So we can still tap into all of the equity, or not all, but we can still tap into some of the equity that we have without replacing that 3% interest rate that we have. And then we only pay for what we actually use. When you do a cash out refinance, as soon as that loan closes, your cost goes up. Whether or not you actually use those proceeds doesn’t matter, you’ve got that new loan in place and you’ve got to pay for that. With the HELOC, you’re only paying on what you actually use. Again, that’s why it’s kind of like your credit card. And then the final option is just selling. And sometimes selling can just kind of be the cleanest exit on a deal. And depending on how you set it up or what the bank says, it might actually allow you to tap into more of your equity.Now there’s still closing costs. When you sell a property, you have to pay fees and agents and all these different folks, you’re never going to get 100% of your equity, right? But sometimes you maybe can get into more of your equity than you will be able to through a HELOC or a cash out refinance.

Ashley Kehr:Especially if it’s your primary residence.

Tony Robinson:Yeah, especially if it’s your primary, because there’s some tax benefits there. And even if it’s not a primary, there’s 1031 exchanges you can do to offset some of the tax benefits as well. But I think to actually answer Xavier’s question, let’s assume that it is his primary. My recommendation would be, hey, pull up HELOC on this property while you’re still living there, that’s going to give you the ability to tap into those funds without replacing the current debt you have on the property, and you can use it or not use it today. Then once you decide to move out, you place a tenant, and you can then use that HELOC to help you go out and bur your next property, or maybe do a live-in flip at your next property, and you can just kind of recycle that same process. Again, we interviewed so many different folks who have used some version of recycling their primary residences over and over and over again to build their portfolio.And you look up five or 10 years and you’ve got enough cashflow coming in from these really low down payment options to really sustain your lifestyle. So I think that would be my recommendation for Xavier. What about you, Ash?

Ashley Kehr:Yeah. I think one other question to kind of ask himself is, what are you going to be using this money for? So depending if you got 50,000, would it be for a down payment? And then you got to think about, okay, how am I going to pay back the line of credit? What is your return going to be on this new money for this new property? So maybe it does make sense refinancing to a 6% rate because of how good the opportunity is and how much more money you’re going to make and better return off of this new investment. Or maybe you’re going to invest in something that isn’t as loanable, I guess. Maybe if you’re going to use this money to purchase a property that can’t get debt onto it. So having your debt rolled into your current property, but knowing you’re going to own this other property free and clear and just make sure you’re setting aside some of the rent from that property to pay the other mortgage too.That’s what I’ve done in the past on some properties is I’ve kept a couple properties free and clear and I’ve just refinanced another property and took the cash from that to pay the other one. And now both of those properties fund the one mortgage. So I only have one property that has debt on it and is held as collateral instead of two. So that’s real life monopoly. So it’s an option to look at two. Real life monopoly. My God, real estate is money management and moving around. I was with one of my friends and she said, “My God, it’s just constantly you feel like you have no cash because it’s just constantly moving from place to place to place to place.”

Tony Robinson:But that’s what it takes. That’s what it takes. Real life monopoly, guys. All right. Well, we’re going to take a quick break before our final question, but while we’re going, if you guys don’t know, Ash and I also have a YouTube channel and you can watch us, watch our smiling faces. If you head over to youtube.com/realestaterookie, you can find us there and yeah, you can hang out with me and Ash in person, quote unquote. All right, we’ll be right back after we’re from our show sponsors. All right guys, welcome back. Our final question today comes from Chris in the BiggerPockets Forums and Chris says, “We’re about to close on a duplex in Ohio. Congratulations, Chris. It’s always exciting. It’s our first property. Both sides are currently vacant. We’ve been evaluating property managers and considering self-management if we do it ourselves. I’m wondering if a quality handyman, basic management software and resources for an Ohio lease and tenant screening framework would be sufficient.We live out of state, but have connections to the area and visit a couple times a year.” The easy answer is don’t do it instead, pay the 10% for a property manager, but we are evaluating whether taking the harder path is worth it. What are your thoughts? All right, Ash, you are our resident property manager expert. The question here is, does the quality handyman, basic management software and the right resources for tenant screening and leases, is that enough for someone in today’s day and age to manage their own properties, even if it’s remotely?

Ashley Kehr:100%. I have done property management company outsourced. I have done full self-management with maintenance and I do everything to transitioning to self-managing with a system in place and using property management software. I’ll say right now, even though a property management company can say they’re full service, you still have to be an asset manager and still have to do some work. For me, the perfect kind of split is self-managing, but having systems and processes and having a handyman and having people to support you and help you building a team, I guess is what I’m trying to say. And the biggest thing is going to be the boots on the ground, the handyman. You can find plumbers, you can find electricians, build your Rolodex of those contractors. The hardest person, in my opinion, for me to find is a quality handyman that is available to do the most simplest task.For example, in some properties, there’s cathedral ceilings. The tenants, I cannot expect them to have a ladder to go up and change the beeping battery in the smoke detector. So having somebody that will go there to do a simple thing, a cabinet falls off the hinges or something, having them go and screw it back into place. That is, to me, the most challenging work to get completed are these little minuscule things that other companies and vendors are not going to go out or they’re going to charge you a ton to be able to do this. I had before the handle fall off the toilet where you flush it and you pay a plumber to go out there. You’re talking a minimum $200 just to get them there. So I think that really is the biggest thing. If you have a handyman that’s going to go out and do these little tasks for you and also not charge you an arm and a leg to be able to do these things, that will be so, so helpful.And maybe they even have their own Relodex of plumbers, electricians, HVACs, things like that, that they can outsource when it becomes something that is above and beyond their scope of work, but also make sure they’re available. One of the questions I would ask them when kind of talking with them to use them is, what is the expected timeframe for you to get to a property to make a repair? And is it 80% of the jobs they do are done within 48 hours, trying to ask what their availability is. Are they available on weekends for emergencies, things like that too, and kind of get an understanding of when you will be able to use them or not, because that will kind of be the biggest thing. I’ll use TurboTenant for property management software. There’s also rent ready. These are two great ones for your first property if you don’t have a huge, large portfolio and they pretty much, that software takes care of the rest.Rent collection, tenant screening, lease agreements, e-signatures, all of that can be done through this software. And there’s really … The only other extra piece I have is Baseline is my actual banking software. But other than that, you don’t really need any other tool, software or app beyond that.

Tony Robinson:Last thing I’ll add, property managers, eight to 10% maybe of your rental income, sometimes they’ll charge fees as well for actually getting your place leased. So they’re not cheap is my point. But depending on you as an individual, even if you feel that from a tactical standpoint or maybe a technical standpoint, you can execute on all these things. If you just know you’re really going to hate it and you’re not going to enjoy it and because that you won’t do a good job. I mean, let’s say a property sits vacant for two months if you try and do it by yourself versus two weeks if you have a professional property manager. Well, they’ve just kind of paid for that additional eight to 10% by getting the property filled more quickly. So just do a little bit of self-reflection. The tools are out there, but just ask yourself, “Do I actually think I’ll enjoy doing this and that I can actually do a good job at it?” And if you can say yes to both of those, then to Ashley’s point, it’s very much a possibility to self-manage today, even if it’s remote.

Ashley Kehr:Well, thank you guys so much for joining us today for this rookie reply. I’m Ashley and he’s Tony, and we’ll see you guys on the next episode.