- Successful real estate investors have used HELOCs to grow their portfolios and build wealth.
- A home equity line of credit lets you borrow against the most recent appraised value of your home.
- There are risks and consequences if you fall behind on your HELOC payments.
It is possible to get into real estate investing with a small salary.
Florida-based investor Mark, who prefers not to share his last name for privacy reasons, is living proof that he has never made more than $52,000 a year on a police officer’s salary. . Yet he managed to build a real estate portfolio of 25 homes in less than five years and take early retirement at age 50. Insider verified his ownership.
He used a variety of strategies to find the cash to scale, from taking out a 401(k) loan to using a self-directed IRA.
To finance his first-ever investment property — a $100,000 single-family home in Virginia’s Shenandoah Valley — he took out a home equity line of credit (HELOC).
When he bought the property in 2017, he had about $25,000 in savings, he estimated. He didn’t want to use all of his nest egg to cover the down payment and closing costs, which is where the HELOC comes in.
On the $30,000 HELOC he opened, Mark used about $17,000 of his total limit for the down payment on the purchase of the property and covered the rest of his initial costs with the savings he already had on hand.
Mark was in a good position to take out a home equity line of credit because he had already paid off his primary residence, a single-family home he and his wife purchased in 1998 when they moved to Virginia after his career in the Navy. They paid off the mortgage early in 2015.
“If someone is in the same situation as me, their primary residence is paid off, they live cheap and they just want a little help, using a HELOC can be a great way to access a small amount of cash with a competitive interest rate,” Mark told Insider. “A lot of times that’s cheaper than what a mortgage rate would be.”
How HELOCs Work
A home equity line of credit lets you borrow against the most recent appraised value of your home to access cash. You can get one almost anywhere mortgages are offered: major national banks, local independent banks, credit unions, and online-only banks.
It works the same way as a credit card – you get a credit limit that you can borrow against for a set period of time, usually five to 10 years, called the “drawdown period” – but the money you borrow comes from the equity in your home. . Once you’ve opened a HELOC, you don’t have to use it right away. You can use what you need when you need it. You might even open one and never use it.
During the draw period, you can usually withdraw money in different ways: a credit card linked to the account, a cash withdrawal or an online account transfer. You’ll have to pay monthly minimum payments once you start withdrawing, which are usually just interest during the drawdown period, but you can also pay your principal back if you want.
Exact borrowing limits may vary by lender, but most HELOC lenders will allow you to borrow up to 85% of the value of your home (minus what you owe). However, you don’t need to withdraw that much.
Mark, for example, wanted a modest HELOC. His house was fully paid off and was worth about $200,000 at the time, meaning he could have taken out about $170,000, but he chose to borrow $30,000, or about 15% of the value of his house. home.
Note that HELOC lenders generally require you to have a high credit score (at least 620 and sometimes above 700). You must also have the equity in your home, which means that the amount you owe on your home is less than the appraised value of your home. Lenders may also look at your income and debts and require a debt-to-equity ratio of 40% or less.
Don’t confuse a HELOC with a home equity loan, which gives you a lump sum up front. HELOCs are credit accounts and you can borrow as many times as you need up to a certain limit, making them ideal for situations where you’re not sure how much you’ll need to borrow.
For example, if you are doing a renovation and you think you need $40,000 but end up finishing the project for $25,000, you can simply withdraw the $25,000 you need and owe interest on that amount. . However, if you used a home equity loan and took out $40,000, you would receive that money in a lump sum and owe interest on it all.
You don’t have to use your HELOC money to fund home-related expenses. You can technically use it to fund anything from starting a business to paying for college.
“I remember sitting in the office at the credit union and saying, ‘So when I get this HELOC can I spend it on anything I want?'” Mark recalled. “And the lady was like, ‘Yeah, whatever you want.'”
That said, if you want to use one to build wealth, you won’t want to use that money to fund a vacation or a new car, for example. If you choose to use it, you’ll want to be smart with how you do it.
Reimburse a HELOC
HELOC terms vary from lender to lender, but generally have a repayment period of 10 to 20 years and come with a variable interest rate. Rates tend to be relatively low compared to other means of borrowing: in July 2022, the average interest rate for a $50,000 HELOC was 4.92%.
When the repayment period begins, you can no longer borrow from your line of credit. You will repay your loan, including principal and interest, in monthly installments.
Mark immediately began paying back his principal and interest. He got a tenant in the property he bought with HELOC, started collecting rents steadily, and was making about $220 a month, he said. He put some of that money into savings and used some to pay off his HELOC balance.
The risks of using a HELOC
If you fall behind on your HELOC payments during the drawdown phase, your lender will likely prevent you from borrowing more. You may be able to work out a repayment plan where you resume your monthly payments plus a bit more to catch up.
If you are unable to repay, ultimately your lender may foreclose on your home and you could lose it to the bank.
There are also upfront costs that come with HELOCs, such as an application fee or home appraisal fee. You’ll want to avoid a HELOC if you can’t afford these expenses.
Keep in mind that you don’t want to stretch your debt to the max. When you do a HELOC, you take out the equity in your home. If the market goes down, you could be over-leveraged and owe more on your home than it’s worth. With house price growth set to decline in 2023, over-indebtedness is a big risk right now.
Using a HELOC to Build Wealth
As mentioned earlier, you can use HELOC money to fund anything.
Ideally, you want to use the money in a way that will help you build wealth. This could mean buying a rental property that will generate positive cash flow, which Mark has done, or financing home renovations to increase the value of your property.
Mark is just one investor that Insider spoke to recently who has successfully used a HELOC to buy investment property and build wealth. Bryce DeCora, a 30-year-old Washington-based real estate investor, took out a home equity line of credit to expand his real estate portfolio and ended up becoming an “Airbnb millionaire.”
It was risky, he told Insider. At one point, he had a $284,000 mortgage on his first home, a $312,000 mortgage on his second home, and an $80,000 HELOC, meaning he was $676,000 in debt. But the strategy paid off.
Another real estate investor, Amanda Hammett, 43, started using a HELOC. She worked with a local bank and took out a $70,000 line of credit, which allowed her to buy 19 properties at once from the same investor. Hammett now enjoys $6,500 a month in rental income.
“There were risks taking a HELOC on my personal home, but being an entrepreneur has increased my tolerance for risk,” she told Insider. “I knew that to achieve what I wanted in the long term – freedom of time for my family and a comfortable retirement – I had to take this step. I believed in myself and I had to take this risk for my family’s future. I had equity for leverage and was confident in my numbers and the team I was putting together.”
If you want to use a HELOC to build wealth, research the best lender for your situation. You will then gather specific documentation (lenders will want to verify your income, employment, assets, and debts), apply for the HELOC, and close the loan.