What is the Better Option for Landlords? HELOC or Cash-out Refinance.
The answer to this question would depend upon the type of the need of the landlord.
What is the Heloc?
Home Equity Line of Credit is a revolving credit your bank or lender would allow you to have against the security of the equity of your home. It’s a 1st mortgage in case the property is fully paid and Heloc is taken. It’s 2nd mortgage if there is a first mortgage on the property still being paid.
What is the Cash-out Refinance?
If the current value of your house is $500000 with your mortgage balance $250000, and if your lender is allowing you to have a bigger mortgage of $400000, replacing with your existing mortgage, that is called cash-out refinancing. You would get $150000 in your account to use at your will. And you new mortgage balance starts from $400k.
What is better for you depends on what and how do you need the amount?
Both these options are the tools to access the equity build-up in your property. And both the tools are very popular among the landlords, as especially when they need a big chunk of money for the purchase of the next property. If you access cash-out refinance, its a regular mortgage. As soon as you take it, you start paying the monthly installment, which includes the principle and the interest. The HELOC is the revolving credit. So the access is available to you, but you can keep it unused till you actually need the money. You can also use it in parts, can repay full or part of it. Or you may never use it at all!
When and how much money you need?
Do you need the full amount that would be available to you? Do you need it immediately? If the answer to both the questions is ‘yes’, then cash-out refinance is a better option for you. If you need the whole amount but in parts or some now some later basis, then The HELOC is the better option for you.
When you should go for HELOC
More often than not, a landlord comes across the circumstances that would warrant careful consideration of the different options like these. We’ll see an example.
You have set an eye on the property next door to your property for your next purchase. It’s good for the combined re-development along with your property in the future. Your property has a very little mortgage left and you have already ascertained with your bank that either HELOC or Cash-out Refinance wouldn’t be an issue. But you are not sure the landlord next door would sell it, now or ever. You want to try your best to persuade him, even if that means to offer a bit of premium. In such a scenario, you have to be ready for cash purchase. You just need to have access to all the money. But you are not sure when you would need it to use actually.
Heloc would be the best option for you here. As specially when you are not sure of the timeline. You don’t want to start paying the cost of your future purchase in advance.
When you should go with Cash-out Refinance Option
You are ready for your next purchase of investment condo. But you don’t have any particular property in mind. From your experience and knowledge of the market, you know it would take a very little or no time to locate and purchase good investment condo at this time. The first thing you would do is to get qualified with your banker for the cash-out refinance option. Once, you are pre-approved, you start searching for the property. The next step is to purchase it with conditions of finance. Set up both the transaction of cash-out refinancing and the purchase of the new property at the same time. And close both the deals as per the convenience!
The landlords prefer HELOC or Cash-out Refinance against home equity loan or 2nd mortgage
Special Mention to Home Equity Loan or 2nd Mortgage
This is the costlier option than the above 2 options. In general, this is not the preferable option for the landlords. It is a fixed term and fixed rate mortgage which goes on the title of the property after the first charge or first mortgage. Because of the possibility of it having left out without getting paid, in case of bankruptcy and sale of property for a lesser amount than the total borrowed amount, the interest rate is high. It is generally considered a high-risk loan.
Why is 2nd Mortgage costlier than Heloc?
2nd mortgage goes on the title of the property after the first mortgage. So it’s more risk for the lender. Whereas, in the case of Heloc, the lender or bank prequalifies the borrower for the Heloc and offers. So it shows the willingness on the part of the lender to do business with the borrower with good credentials and who has equity in his property. But there may be more reasons like the trend of the behaviour of the borrower attached to the lenders’ decision.
Further reading: Borrowing against your home equity