Skip to main content
No. of Recommendations: 0
Hi All,

I'd like to buy a 2nd rental property in the next few years without taking money out of the 1st one - it will be paid off in 3 years and my wife wants the increased cash flow. What do you think is the best way? I was thinking of doing a HELOC on my primary to come up with the down payment, assuming interst rates are reasonable. Any other ideas? Are no money down ideas realistic? Dean Graziozi mentions several of those in his books.

Any feedback is welcome.

Regards,

Jeff
Print the post Back To Top
No. of Recommendations: 5
I'd like to buy a 2nd rental property in the next few years without taking money out of the 1st one - it will be paid off in 3 years and my wife wants the increased cash flow. What do you think is the best way? I was thinking of doing a HELOC on my primary to come up with the down payment, assuming interst rates are reasonable. Any other ideas? Are no money down ideas realistic? Dean Graziozi mentions several of those in his books.

What difference does it make whether the loan is against your primary residence, against your first rental property or against your second rental property?
No matter what you're going to be sending the bank principal and interest for that loan.
So IMO doing a higher interest rate loan on the 2nd rental property so you have "increased cash flow" on the 1st rental is a net negative to your overall financial health.

Now there might be some tax consequences depending on the loan structure, so you should probably think about that as part of your considerations.
But IMO your wife hasn't thought through that the "increased cash flow" coming into one pocket just means you have increased cash flow going out the other pocket.
That - or - she would rather you sell some of your other investments and get the downpayment from that.
Print the post Back To Top
No. of Recommendations: 2
I'd like to buy a 2nd rental property in the next few years without taking money out of the 1st one

You need to be aware that you cannot deduct the interest payments on a cash-out loan for a rental property unless the cash is spent on the property that secures the loan. So taking a cash-out loan on a rental property is generally not a good way to raise money for a second property.

AJ
Print the post Back To Top
No. of Recommendations: 2
You need to be aware that you cannot deduct the interest payments on a cash-out loan for a rental property unless the cash is spent on the property that secures the loan.

I do not think that is true.

https://www.irs.gov/pub/irs-pdf/p535.pdf

Reading chapter 4, I think any loan's interest (including HELOC on the 1st rental property or even an unsecured loan) could be used as a business expense for the 2nd rental. That is, assuming that you can show that the loan's proceeds were used for buying the 2nd rental. (pretty easy to show $ from a loan going into a separate checking account or money market account, and then going from there to the downpayment for the property, and thereby prove that's what you used the money for)
Print the post Back To Top
No. of Recommendations: 1
FoolishJeff: "I'd like to buy a 2nd rental property in the next few years without taking money out of the 1st one - it will be paid off in 3 years and my wife wants the increased cash flow. What do you think is the best way? I was thinking of doing a HELOC on my primary to come up with the down payment, assuming interest rates are reasonable. Any other ideas? Are no money down ideas realistic? Dean Graziozi mentions several of those in his books."

I am not familiar with Dean Graziozi or his books so no comment thereon.

Most of the no money down ideas I have read seem to rely on finding a desperate or innumerate (or both) Seller, but otherwise have not ever made much sense to me.

Why does it make sense to put your house at risk (via a Heloc or even a HEL) then a loan on the first rental property?

And the only way that your cash flow would be better via a loan on you home versus the first rental is the difference is by the difference in interest rates, unless your wife gets all the cash flow from the rentals and you pay the loans on the home. In that case her cash flow is better and yours is worse, and you have the added risk to your home.

You could see if you could negotiate for the Seller to carry a second mortgage on the second rental but the interest rate would likely be higher for the added risk and your first would need to approve.t

Sell some of your other investments to gather the down payment and closing costs for the second rental.

Regards, JAFO

PS - And I assume that y'all are holding appropriate reserves for non-annual expenses and capital repairs and improvements for the first rental from its cash flow and not simply spending all the free cash flow on current consumption.
Print the post Back To Top
No. of Recommendations: 0
Riffing off foo1bar, I'd look for the option with the best terms, which likely isn't a HELOC.
Print the post Back To Top
No. of Recommendations: 0
How about refinancing the loan on the current rental to get some cash out. If you're only 3 years from paying off the loan, extending the loan term would significantly reduce the monthly payment on that part of the loan. Add on the cash out portion, and you might still be able to end up with a smaller monthly payment than you are currently making while still getting cash out.

--Peter
Print the post Back To Top
No. of Recommendations: 3
You need to be aware that you cannot deduct the interest payments on a cash-out loan for a rental property unless the cash is spent on the property that secures the loan.

I think you're mixing up the personal residence rules with rental properties. You can deduct any loan interest on a rental property - secured by that property or not - as long as you can trace the loan proceeds to use on the rental. So a loan secured by one rental could easily be deducted as an expense of a different rental as long as that is where the loan proceeds were used. Even a loan secured by your residence could be deducted as a rental expense if that is where the proceeds were used.

--Peter
Print the post Back To Top
No. of Recommendations: 0
Agree with some other commenters that your wife's reasoning makes no sense. Best option will be to do cashout on current rental as you'll be able to fully write off the interest on your schedule E and cannot write off the interest if you take a HELOC on primary to buy a rental.

Furthermore, if only 3 years left; new cashout mortgage could potentially increase your cashflow (assuming you got a mortgage 10+ years ago). With the Trump tax cuts, one gets way better write-off on a rental vs primary residence. As most people nowadays take the higher standard deduction.
Print the post Back To Top
No. of Recommendations: 2
you'll be able to fully write off the interest on your schedule E and cannot write off the interest if you take a HELOC on primary to buy a rental.

The interest on a loan for money used to buy a rental property is an expense (deductible) for that rental property.
Does not matter if it's a HELOC on your primary residence, a loan secured by another property, or an unsecured loan. What matters is that you can show it was used for that investment.
Print the post Back To Top
No. of Recommendations: 0
"The interest on a loan for money used to buy a rental property is an expense (deductible) for that rental property.
Does not matter if it's a HELOC on your primary residence, a loan secured by another property, or an unsecured loan. What matters is that you can show it was used for that investment."

foo1bar, very interesting. I'm no accountant but makes sense. Since the 1098 issued for HELOC would primary residence listed on it, would that cause any special IRS tax form?


For OP regarding HELOC: another downside of using a HELOC is the variable rate. In this rising rate environment, think you would be better off obtaining a mortgage or if possible: home equity fixed rate loan.
Print the post Back To Top
No. of Recommendations: 0
I'd like to buy a 2nd rental property in the next few years without taking money out of the 1st one - it will be paid off in 3 years...

So you have time to shop around, for a rental AND a bank loan (if needed).

Best case scenario (and what I did 7 years ago), paid off the mortgage on my first rental property, then bought my second. Used some cash flow from my 1st property to help pay down the mortgage on my 2nd quicker. At that time I still needed 20% down even though have a FICO score of 820 and rental properties have good cash flow. Could have been that I was dealing with a smaller bank in a smallish city.

If you find your dream rental deal next week, refinance current mortgage which should free up cash flow to use on 2nd property.

Either way, good idea to start talking to bankers now and get the paperwork moving. That way you can shop around for best rates/deals and have "loan in hand" when you start talking price with sellers.

As an aside, I'm a proponent of LLCs. And I hold my separate rental properties in separate LLCs. Offers some protection but that varies from state to state.

JLC
Print the post Back To Top
No. of Recommendations: 2
Late reply but I would never use my primary residence to fund a rental property. I may be different but I viewed rentals as a business and separate. They needed to at least support themselves. And there is work involved.

Has your wife seen a net worth statement for the two of you ? It's a disservice to her to not work with her to understand your(couple) finances. What would she do if you got hit by a bus tomorrow ?

Speaking of which - how's the term life insurance on both of you ? ;)
Print the post Back To Top
No. of Recommendations: 1
Thanks for the responses.

Yes, you guys see the obvious and let me explain.

1)My preferred option would be to do a cash out-refinance on the 1st rental property, which is almost paid off (only 3 years left to pay), and then use that $$ as a down payment on a 2nd rental property.

However, the rental property (our old house) is in my wife's name, her mom contributes 12K a year to pay it off faster, and her mom made us promise not to re-finance or anything. It doesn't make financial sense but unfortunately I can't use the property to get cash out.

The only good news is it is providing about 10k/year in cash flow to cover any expenses and to increase our income. Once its paid off, it will provide about 30k/year in cash flow minus any expenses.

2)I'd like to at least break-even to start if I buy a 2nd rental property but I need to come up with the down payment. I don't want to sell any stock to raise cash (especially since they tanked recently) and so a HELOC seems like it might be the best way, even though the terms wouldn't be the best.

3) I'm financially stable, age 46, with a NET worth over 1 million dollars, have life insurance, so I'm not very worried about putting my primary house at risk with a HELOC.
Print the post Back To Top
No. of Recommendations: 1
FoolishJeff: "Thanks for the responses.

Yes, you guys see the obvious and let me explain.

1) . . . .

2) . . . .

3) I'm financially stable, age 46, with a NET worth over 1 million dollars, have life insurance, so I'm not very worried about putting my primary house at risk with a HELOC."


Some of the initial responses might have ben different with the missing information.

With regard to HELOC (v. HEL). Many (if not most or all) HELOCs are variable rate loans, which is not ideal in a rising rate environment) and, IIRC, many are callable and future advances can certainly be cut-off by the Lender. You might want to consider a home equity loan (HEL) with a fixed term and rate instead of a HELOC. At the very least, you should shop and compare the terms.

Regards, JAFO
Print the post Back To Top
No. of Recommendations: 0
Thanks, I should have explained the situation more clearly.

I wouldn't do a HELOC or home equity loan unless it was a fixed rate.

I think the advantage of a HELOC is that you typically are only required to pay interest during the draw period (typically 10 years).

I would use the extra income from the 1st rental to pay off the HELOC during the draw period.
Print the post Back To Top
No. of Recommendations: 0
I think the advantage of a HELOC is that you typically are only required to pay interest during the draw period (typically 10 years).

That would be wrong. Or at least stated poorly.

You probably pay interest only during the draw period. After the draw period, you have to start paying principal as well as interest.

--Peter
Print the post Back To Top
No. of Recommendations: 0
IIRC, many are callable and future advances can certainly be cut-off by the Lender

I haven't seen any that are callable.

I've seen that they can ask for full repayment if you are delinquent.

The lender being able to freeze the credit line at whatever has been withdrawn so far is in my experience common/expected.

I certainly agree it's a good idea to compare HEL options and HELOC options.
And I'd recommend checking your local credit unions - I have gotten excellent HEL/HELOC rates from credit unions.
Print the post Back To Top
No. of Recommendations: 0
Yes, if the market tanks and the price of your home goes down, they can freeze your credit line. I haven't read about any that are callable either.
Print the post Back To Top
No. of Recommendations: 0
I wouldn't do a HELOC or home equity loan unless it was a fixed rate.

You can find HELOCs that allow you to fix all/part of the amount borrowed. Just keep in mind that the fixed rate will be at a higher rate than the variable rate that you would otherwise be paying at the time that you fix that rate.

I think the advantage of a HELOC is that you typically are only required to pay interest during the draw period (typically 10 years).

No, that's not very common any more. Bank regulators have pushed banks away from allowing interest-only loans, even on loans that are being held in the bank's portfolio. As a consequence, most HELOC lenders require at least a small amount of principal repayment, even during the draw period.

I would also point out that for the HELOCs that do offer interest-only during the draw period, the interest will be at a variable rate. The feature of 'fixing' a portion of the HELOC generally requires that you amortize the loan amount over the remaining term of the HELOC. So your two stated goals of (1) paying only interest and (2) paying a fixed rate seem to be in direct conflict.

I would use the extra income from the 1st rental to pay off the HELOC during the draw period.

Why don't you just save up the extra income from the first rental (and any other income you want to devote to real estate investment) in order to come up with a down payment? That way you don't need to borrow for the down payment at all.

AJ
Print the post Back To Top
No. of Recommendations: 0
You probably pay interest only during the draw period.

Use to be that was true. Since the financial crisis, most HELOC lenders require at least a small amount of principal repayment even during the draw period.

AJ
Print the post Back To Top
No. of Recommendations: 1
I haven't seen any that are callable.

I've seen that they can ask for full repayment if you are delinquent.


It's not just being delinquent. Lenders can also require payment of a HELOC in full if the property value drops or if they learn that the borrower's circumstances have changed - like because the borrower lost their job, or they moved out of the house that the HELOC is collateralized by.

The lender being able to freeze the credit line at whatever has been withdrawn so far is in my experience common/expected.

Having worked in the mortgage servicing industry during the financial crisis, I can assure you that HELOCs do get called.

AJ
Print the post Back To Top
No. of Recommendations: 0
I appreciate everyone's input.

Sounds like a HELOC might not be the best way to go. If its callable, that is kind-of risky. I might have to sell stocks during a recession to cover, which could really hurt in the long run. Might be best just to save up for the down payment using some of the $$ from the 1st property.
Print the post Back To Top
No. of Recommendations: 0
Sounds like a HELOC is best for short term cash for remodeling, if needed. If the amount of credit used is relatively low, it is not very risky.
Print the post Back To Top
No. of Recommendations: 1
However, the rental property (our old house) is in my wife's name, her mom contributes 12K a year to pay it off faster, and her mom made us promise not to re-finance or anything

Another wrinkle - are you in a community property state and/or do you have a prenup ?

I'm financially stable, age 46, with a NET worth over 1 million dollars, have life insurance, so I'm not very worried about putting my primary house at risk with a HELOC.

I.....my....

Not we, our ?
Print the post Back To Top
No. of Recommendations: 0
I live in Oregon, which is not a community property state. We have no prenup.
Print the post Back To Top
No. of Recommendations: 0
I think the advantage of a HELOC is that you typically are only required to pay interest during the draw period (typically 10 years).

No, that's not very common any more. Bank regulators have pushed banks away from allowing interest-only loans, even on loans that are being held in the bank's portfolio. As a consequence, most HELOC lenders require at least a small amount of principal repayment, even during the draw period.



We just got a HELOC at our credit union and we are only required to pay interest during the 10 year draw period.
Print the post Back To Top
No. of Recommendations: 0
Did you get a fixed rate?

Is the interest rate determined by when you take out the line of credit or when you draw from the credit line?
Print the post Back To Top
No. of Recommendations: 1
Is the interest rate determined by when you take out the line of credit or when you draw from the credit line?

For variable rate HELOCs, the margin above/below your index is set at the time that you take out the line of credit. Then, interest rate on whatever balance you have is calculated based on that index +/- your margin, and will be calculated on a daily basis. Many HELOCs use the prime rate as the index, and the range around that index is often +/- 1%

So, as an example, if you have a loan that's 0.5% below the prime interest rate http://www.fedprimerate.com/wall_street_journal_prime_rate_h... that means from 3/15/20 - 3/15/22, with a prime rate of 3.25%, your interest would have been calculated at 2.75%; from 3/16/22 - 5/3/22, the prime rate was 3.5%, so your interest would have been calculated at 3.0%, and since 5/4/22, your interest would be calculated at 3.5% If your HELOC rate was the prime rate + 0.5%, then just add 0.5% to the prime rate to determine your interest rate, instead of subtracting it.

Since HELOCs that offer fixed rate options generally let the rate float until the customer asks for the rate to be fixed, they don't fix the rate until that time. However, they also generally only fix the rate for that part of the balance that the customer asks to be fixed - keeping the rate on the remaining line of credit as a floating rate. With HELOCs, you generally don't get a fixed rate unless you've actually drawn on that line of credit. And if you pay down some of that fixed amount, that part of the line goes back to being floating.

If you really want a fixed rate home equity product, you probably should look for a HELoan, with a fixed rate and a fixed term, and no ability to do additional draws. Since your intent is to use the proceeds for the downpayment, the inability to make additional draws shouldn't be an issue.

A word of caution when getting a HELoan: Be sure you understand how the payment term is amortized vs. the actual term of the loan. The HELoans that I've had in the past have calcluated the payment based on amortizing over a 30 year period, but the loan required a total payoff after only 15 years. So if you don't want to be forced to refinance the remaining balance at the rates prevailing 15 years after you took out the loan, you will either need to save up the projected balloon amount within the first 15 years in order to make that balloon payment, or make (higher) payments based on a 15 year amortization schedule, rather than required minimum payment that's based on a 30 year amortization schedule. Your lender's amortization schedule should show you the balloon payment that will be required, and you can use a payment calculator to figure how much extra you need to pay to pay the loan off in 15 years, rather than 30.

AJ
Print the post Back To Top