Cash-Out Refi Or HELOC: How To Pull Money Out From Your Investment Property

When we bought our first international rental property (Condo Boom in Tamarindo, Costa Rica), we decided to do a cash-out refi of another investment property to buy it all cash. Damn Millennial asked us a question on Twitter that we also asked ourselves:

Out of curiosity why did you choose the cash out refi over the Heloc? The way I understand it the cash out is more expensive isn’t it? As you must refinance the total amount and then pay fees on that. Vs. HELOC you just pay for appraisal and opening a line.

Oh, Damn Millennial, I mulled over the exact same issue, and thanks for prompting us to go into more detail on the topic!

What is a HELOC

For those new to the HELOC, it is a home equity line of credit, and is exactly what it sounds like – a line of credit you can draw against the equity in a home that you own.

When we bought our very first property in Little Silver, New Jersey in 2002, a rise in real estate value enabled us to get a $150,000 HELOC, which then enabled us to buy our first rental property. We sold our New Jersey property in 2014 so closed that HELOC, but have since gotten two more HELOCs on other properties we still own.

Flexibility is a big advantage of HELOCs

Because HELOCs are lines of credit, you only pay interest on what you draw down. HELOCs often carry an annual fee to keep the line open, so you may pay something even when your balance is zero, but it’s a small amount. For example, on one of our HELOCs, we paid $200 per year for a $64,000 line, and the fee was waived when we drew a certain amount.

In addition to using our New Jersey HELOC to fund our first real estate investment, I used that line to smooth out our cash flow when I was getting my coaching business started in 2008, and we used that line for ad hoc expenses, such as maintenance issues.

We may use a HELOC to pay for college expenses. The flexibility to access tens of thousands of dollars when needed without going through a mortgage application process each time is a big advantage of HELOCs to other types of loans.

HELOCs are not always available

However, HELOCs are not available to just any property. We were able to get a HELOC on our New Jersey property because the rise in home prices gave us enough additional equity in the property to borrow against.

Lenders will typically issue HELOCs only up to 70% of a home’s appraised value (sometimes the limit is 75% but sometimes it is just 65%). If you have a property where you put 10-20% down, and it hasn’t appreciated much or you haven’t paid enough principal down, then you won’t have enough equity in the home to qualify for a HELOC.

Furthermore, lending qualifications for HELOCs can be more restrictive. The lender who issued our two other HELOCs only lends to owners with a maximum of four investment properties. We now have 14. Another lender, who works with owners beyond four investment properties, only does mortgages (which includes cash-out refinances) not HELOCs.

HELOCs have some structural disadvantages

In addition to the limited availability, HELOCs are variable rate loans.

Our HELOCs were tied to the prime rate, which was great when interest rates were super low, but in a rising interest rate environment like the one we have now, our interest rate was ticking up .25% with each rate hike. A .25% increase doesn’t sound like a lot, but on a $100,000 HELOC, that’s an additional $250 per year, and multiple interest rate hikes can happen within a single year.

Furthermore, unlike mortgages which can extend for 15 or 30 years, HELOCs are typically open for just five to ten years at a time, after which you need to reapply.

HELOCs can also be called (i.e., closed!) at any time that the lender feels like there isn’t enough equity in the property. Our first HELOC for the New Jersey property was called in 2009, though we were able to quickly open another one, courtesy of a helpful lead from our business network.

We actually closed down one of our two post-New Jersey HELOCs last year because our five-year period ended, and we now have more than four properties, so our lender wouldn’t extend. Our other HELOC expires next year, and we are researching alternatives for that one – most likely a cash-out refinance.

Refinancing offers fixed rates, longer terms, and easier availability

On the flip side, a cash-out refi negates the downsides of a HELOC. We did a cash-out refi for two of our investment properties in order to pool enough money to pay for our Costa Rica property outright.

Interest rates were fixed for 30 years at 4.625% versus 6.25% variable for five years for the HELOCs we had open. Our national mortgage lender of choice was available to do the deal because they lend to owners of up to 10 mortgaged properties (we have 16 properties, but mortgages on just 7 of them).

While I’d love to have the flexibility of a HELOC, we couldn’t get one for this deal and got great terms on the cash-out refi.

Costs are a toss-up

Application fees on a HELOC are typically lower than on a cash-out refi, but rates are higher. So depending on how long you are planning on holding the debt, you may be better off paying the higher upfront costs of a cash-out refi to get the longer paydown and lower, fixed rate.

You have to do the math. You also want to do the math on whether you want to buy down the interest rate, how much cash you want to pull out during the refi, and whether you want to pay closing costs upfront or roll them into the loan.

Not all of these options will be available – it depends on the lender and how much equity you have in your property – but these are some of the decisions you need to make when you opt for a cash-out refi.

Our choice for cash-out refi

In the cash-out refi or HELOC debate, we had no choice but to pick the cash-out refi for our Costa Rica purchase.

However, given the timeframe of our investment (we want to hold Condo Boom for the foreseeable future), it is likely that we would have picked a cash-out refi anyway. The longer term and lower fixed interest rate are more important for a long-term hold.

The volatility and significant start-up costs of a vacation rental also made locking in the loan characteristics desirable to us.

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UPDATE: Based on a couple of comments to this post, I realized a key point about HELOCs needs to be highlighted if you’re considering this option for your rentals:

Eligibility for a HELOC is based, not just on having enough equity in the property, but also on having enough credit worthiness for the line – i.e., the lender needs to know you’re good for what you borrow and will be able to pay it back.

If you have $1 MM in equity in a property but you have no provable income and a terrible credit score, you’re still not likely to get a HELOC on that property because once you spend the line, how will you make payments? Therefore, if you’re considering a HELOC, you need to check the amount of equity you can borrow against and your credit profile.

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You need to do your own calculation on cash-out refi or HELOC based on your situation and investment goals.

Have you pulled out equity from an investment property? What type of loan did you use?