WatchA few topics center on HELOC as bad bad bad, I don’t see it. Sure, you can get in trouble, but the core reason makes a whole lot of sense. This has nothing to do with whether the house is a buy or not, go up or down so please no comment in this area., just the argument/decision of HELOC or no HELOC.
To illustrate, I will use my own situation as an example as that is the easiest to articulate and explain, but the overall argument is probably very similar.
Say House 1M
Home rents for 4,000.
Interest rate 2.75% (5 year ARM)or 15 year fixed.
Property tax 1.20%
Insurance/Maintenance 5K a year
Tax Benefit 33% net of state deduction
1M * (2.75%+1.2% @33%) + 5000 = $31,300
31,300 = Interest, tax, insurance and maintenance net of tax deduction
48,000 = annual rent based on current
Buying is 17K less than renting
* I also have principle reduction of approximately 30K a year.
*We fund our retirement fully (34K) which returns at least 50% and reduces income tax further by 12K (deferral of higher tax rates for lower tax rates).
* So between funding for retirement and house mortgage, it does leave 65K tied up in forced savings and retirement savings. The mortgage returns 17K a year in rents saved and the 401K is closer to 50K after tax deferral benefit and match. Notwithstanding San Francisco is a tremendous investment for the long term anyway. Basically my decisions tie up a lot of cash for assets accumulation as cheap as possible
* With cash tied up for the above for lucrative opportunity, this is where the HELOC is a godsend. It is a great equalizer in the lack of liquidity.
* Why take it. First the cost to open one is miniscule, maybe $400 out of pocket. Second, the interest rate is around 3% and tax deductible depending on the situation.
* My plan for the HELOC is to pay for private school and improvement, whenever applicable. (100K deductible for education) and the rest for improvement, all deductible. Net of tax, the interest is 2%. So while I increase debt, my assets increase significantly faster.
* 2% net of tax is less than corporate bonds and preferred shares from ATT, Bank of America, etc. This is for the low hanging fruit activity, the easy activity is 401K and the known saving from renting.
* So in the end, I am investing my cash that pays 50% return, save 17K in rent/buy and/or buy bonds that pays 4-5% and or keep cash available for enjoyment. My borrowing cost net of tax is 2%. Explain to me how utilizing a HELOC is bad?
* If shit hits the fan, you’re better off with a 80% LTV ratio than a 50% LTV ratio, presuming all the assets are shifted into your sheltered 401K and other limited sheltered assets. If interest rates go up, accelerate the payments.
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Scottsdale, AZ
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I took a heloc for $47K at 4.5%, no closing costs. They paid the first month payment, and gave me a 1% gift card. Then, I took a $40K in credit card cash advances one with 2% up front, 0% interest for a year, the other with 3% up front, 0% interest for 18 months. I bought a house with the money. Rented it for $1095. I'll pay off the credit cards as they come due, I'm not concerned at all about the heloc.
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The formula for leveraged return is:
But in the end, if you can make more (after taxes) on the borrowed money than you pay on the borrowed money (after taxes), then you are doing what every American bank is now successfully doing.
We pulled $300K of equity out and invested it. Making 15% on money I am paying 3% on.
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I'm sorry, but it's just too much math. You guys really hurt my little brain. Ouchhhhhh...
It's essentially free money. Why not borrow it, invest it and make the spreads? On top of it, you might get 30% to 80% appreciation on the properties in the past few years.
Now you can refinance, pay-off the borrowed money, get some cash out, tax-free or tax-deferred depending on how you handle it, and go buy more rental properties. Someone will pay-off your mortgage and put several hundred dollars in your pocket monthly.
You offset the positive cashflow with depreciation, pass the properties onto your heirs, and you'll never have to recapture the depreciation. Your heirs will get a step-up in basis.
It's something like that.
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I dunno who makes the rules.
* They let you depreciate and defer.
* Don't like you property, do a 1031 exchange.
* No basis, huge capital gain... gotcha, but
* step up basis so no basis become full basis. Wipe out all the gains that were never taxed.
lol
between prop 13 and this, That figures why nothing is for sale in San Francisco.
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bmwman91's website
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What you guys are saying makes perfect sense. However, the attitude is leaning heavily on the "THERE'S NO RISK EVERYONE'S A WINNER" side these days. It all works great as long as your debt-funded investments continue to perform. As of right now, it makes sense because equities are being heavily pumped and debt is insanely cheap. My big question to you guys is a famous one. "How do you know when to get out?" I'd assume that it's time to go when people like me decide to try their hand at it...shear the sheep and walk away right?
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BMW,
I don't know about SFace, Iwog and Roberto. As of right now, I'm planning to hang onto these properties until the day my soul leaves my body. It was an 80 years cycle. It was an opportunity once in a lifetime. These 2-bedroom condos will never sell for less than $250k ever again. They were selling for $150k in 2009 - 2011. I was fortunate enough to lock in five of these in early 2012 for $137k - $158k. They are currently being rented for $1,550 - $1,750/month. You can run the numbers.
My goal is to keep on extracting the equity out of these properties through refinance. As long as you don't over extract the equity and turn these into alligator properties, you should be fine. The goal is to stay very liquid and transfer most of the risk onto the lenders.
We will continue to have boom and bust cycles in the Bay Area on a smaller scale compared to the last one. Things will gradually become more expensive in the Bay Area after each cycle. This is how it will play out in the future. Try to get off the treadmill as soon as you can. You will lose a lot of motivation as you age. It sucks to be working in your 50's, 60's and 70's because you can't afford to retire.
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bmwman91's website
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I guess that my question to you would be, "how will you pass the properties on to your kids without also passing on all of the HELOC debt that you owe?"
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Madison, WI
Well no shit, everybody knows borrowing is meant to be rewarded, it's baked into the cake. More money, more spending, more borrowing, more taxes, more vacations, more cars, more energy, it's all good.
And the guarantee or cake just get better if your a wiser investor or smart with the money.
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E-man says
we all would be in RE.. but that is not the case as you look around.. only a small percentage of people actually have RE as some investment. My home isnt
an asset or some investment.
E-man says
the 89-92 downturn was a result of economic events which crippled our SV industries.
the 2000 downturn wasnt sweet as we lost many employers in the next 10 years.
at best you can say our economic booms, 1975 to 1995 only allowed homes to appreciate at rate of inflation.
there are real investments which provide better returns easily executed and retained. For many, selling their residence isnt an option.
and if this next bust happens ... it wont be pretty...all your RE buying will be based on some past glorious
economy, which doesnt really exist any longer.. just a shadow cast from empty tech buildings.
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bmwman91 says
you cant.. you die, the lender takes back your home as collateral.
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treatmentreport's website
E-man says
I believe that bay area cycles will not be on small scale any longer. Bay area will resemble the price swings of Singapore real estate (http://www.globalpropertyguide.com/real-estate-house-prices/S#singapore) rather than the rest of US.
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bmwman91 says
They get the debt as well as the equity. It's all part of estate planning.
Say I bought it for $100k, and it's worth $1M by the time I dropped dead. I still owe $750k on it (Max. 75% LTV on investment property or 80% LTV on primary residence). My kids can sell it for $1M, pay off the mortgage, and walk away with $200k tax-free. I got to extract $650k to $700k of equity from the property tax-free over the years. Sounds like a win-win situation for me.
Now imagine I extract $650k of equity x 12 properties over the years. How about 24 or 48 properties. That's a lot of tax-free money. How long does it take a couple to save that much money tax-free? How many free and clear primary residences and investment properties can you buy for your kids, nieces and nephews, grand kids, etc.....
If everything goes accordingly, we will be proud owners/loaners of 16 properties in the lovely Bay Area by this summer. I just have to keep my head down and keep plugging away. Can't achieve this goal listening to the naysayers.
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SFace says
If you make 100K a year the depreciation ability starts to fade out and is gone if you make more than 150K, unless your sole employment is being a landlord. Also there are transaction costs when you do an exchange, etc.
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treatmentreport says
Well, if my projection is correct, all of my $150k condos will be selling for $375k-$400k at the peak of the next cycle. $400k mortgage at 3% is only $1k/month of interest. They are currently being rented for $1,550-$1,750/month.
These condos were selling for $400k in 2006 at 6.5% interest rate, and rents were $1,200-$1,300/month.
My townhouses, SFHs and duplexes are looking great too. I couldn't even believe I have reached this milestone and still counting. It was a little scary at first, but now it's a walk in the park.
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bmwman91's website
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Got it. So it's RE speculation, except this time it's a sure thing. I am seeing a lot of "if" and "imagine." I wish you the best of luck E-man, truly, I do. At least you have RE in an area that is mindlessly coveted by a bunch of foreigners that America gave ridiculous purchasing power to, so maybe they'll still be able to overpay for your properties someday. Americans likely won't be.
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MsBennet says
I'm not sure that is true, i think you just need to meet the active rather than passive activity standard.
AND depreciation isn't a tax deduction, it is a deferment. They want it back when you inevitably sell the property.
I'm planning on paying of all of my credit cards this year, and refinancing one more rental... and paying off all of my personal borrowing. I'm not going to extract equity, I'm just going to collect rent and wait.
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robertoaribas says
Slow and steady wins the race. If I was in the RE game, I'd do it this way. Jacking up leverage does nothing more than turn a conservative investment strategy into a roulette table.
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bmwman91 says
I cannot disagree. Higher leverage = higher risk. However, as long as every single one of your rental can pay for itself and more, you should be fine. The goal is to stay liquid. It's all about positive cashflow and liquidity, liquidity, liquidity.
Actually, we will do some debt consolidation this summer. The game plan is to extract equity from two rental properties and pay-off the house the parents in-law currently live in. It's worth around $650k-$700k, and the outstanding mortgage is $147k.
In 3 to 5 years, there's a very high chance that we will get the equity from my duplexes to pay-off our $390k mortgage. Then we will ask for a huge HELOC. You don't pay any interest on the HELOC until you use it.
As of right now, there's a lot of delayed gratification on my part. It's a lot of land grabbing at for cheap while I still can get my hands on.
I have more deals than I can buy at the moment. Sigh........
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E-man says
way too rich for me! I'm probably done buying for now anyways!
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bmwman91 says
Thank BMW. I'm just playing the odds, and I like my odds with those "if" and "reality."
These condos shouldn't have dropped to $150k. It was mispriced. It was a race to the bottom due to HOA delinquency issues and the mass number of foreclosures. However, they were mopped up by investors. Some of them have started to unload them to first time home buyers at $250k now. Somes are already pushing for $270k to $300k now after they put lipstick on that pig.
My partner and I were projecting these units would be selling for $275k-$280 by the end of this year. With the way it goes now, there's a very good chance that we will be correct. Time will tell.
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treatmentreport says
Treatmentreport,
Thanks for the link. That site has a lot of cool charts. I'll study up on them.
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E-man says
Oh don't you hope........
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robertoaribas says
That is what tends to happen when you are all in, unless you can shit capital.
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Scottsdale, AZ
robertoaribas's website
yup1 says
400K condos? No thanks... I just bought a 4/2 home for 86.5K... should rent for 1100.
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Except 401k, what are other sheltered assets?
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Mobi says
Buy annuaties, or various different type of life insurance policies.
Set up trusts and entity.
Funnel money to you mom/family and inherit it all back.
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Mountain View, CA
bmwman91's website
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Hey E-Man, I sent you an email.
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SFace says
1. I have concerns about insurance companies when SHTF.
2. LLCs?
3. Good idea
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SFAce said: Funnel money to you mom/family and inherit it all back.
A big huh?! Watcha talkin' about Ace? Inquiring minds want to know. My working assumption is that at some point my parents may have to go into managed care and will get stripped of all their assets.
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EBGuy says
Long term Insurance. My mom is 60. Her policy ($3XX/month) covers about 80% of the care or a max of around 6K a month (inflation adjusted) for I think 10 or 20 years. Just pay for that if you want to protect (theirs or your) assets.
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Mountain View, CA
robertoaribas says
WHOA THERE ROBERTA!!!
I thought you were a real estate MOGUL with about $1.5 MILLIONS OF DOLLARS worth of property!!
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San Francisco, CA
E-man says
Wow, I wish I lived with that kind of certainty.
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San Francisco, CA
robertoaribas says
Annual rent at !5% of purchase price! Whooah, Nellie, that is a desparate state of being.
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David Losh's website
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SFace says
Strange, but true, and it comes back with interest, and taxes paid.
We did both long term care insurance, and a commercial building for additional income.
At 95 years old the long term care more than paid for itself, and the small life insurance paid any last bills.
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Well under the current paradigm, you have no risk. You get to keep the profits and if the market crashes, you turn over the loss to the banks, declare bankruptcy and walk.
Assuming you have your primary residence payed off, there is no risk in the game.
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lostand confused says
Will declare bankruptcy protect you from losing your primary residence (it depends on your resident states, right)? Also, why do you want to pay off the primary residence?
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Mobi says
I think s/he meant HELOC against secondary home or investment properties. In most states, the primary residence can have homestead declaration, whereby only mortgages directly pledging the homestead can have lien against it, all other creditors can not attach the homesteaded house.