Don’t Get A HELOC To Invest In Real Estate

Hindsight is 20/20, and as much as I like to share “wins” on this site, it is also my responsibility to share “losses” as well.  I took out a HELOC (home equity line of credit) 5 years ago to buy rental real estate, and have used the HELOC on my primary residence to accelerate our wealth building journey.  In many ways the HELOC has been beneficial to me, however I have had significant unexpected costs, both financial and non-financial from using a HELOC to invest in Real Estate.

Building Home Equity:

We bought our 2nd home in 2011, which we still live in today and plan to live in forever.  We paid $148,000 for this home with a 20% down payment.  I paid extra on the house every month and at the end of each year.  By 2018 I had paid our original loan down from $116,000 to roughly $50,000.  We were able to get a HELOC of around $60,000. This Heloc required a 1.5% payment on the total balance, so each month in addition to the interest there was also a principal payment due.

A year later We went back to the bank and closed out the initial HELOC and got a new one with a higher limit, and this time interest only.  Our interest rate on our home was 4.25%, but the HELOC had an interest rate of 2% for the first year.  We got a new HELOC with a $135,000 total limit and used $50,000 of that limit to pay off our original mortgage at that time.  Now we had a HELOC with $50,000 owed against our primary residence and $85,000 available for rental investments.

2 years later we had effectively paid off the balance that was our primary residence and housing values had increased substantially.  In December of 2021 we got a new home equity line of credit for $200,000.  The interest rate at this time had increased to 3%.  Still, this was a great deal. With $200,000 available I could buy multiple properties at once.

Using a Heloc to Invest In Real Estate With the BRRRR Method:

BRRRR stands for “Buy, Rehab, Renovate, Rent, Refinance” Our overall strategy was to buy houses that no one wanted, with “cash” from our HELOC , fix them up, then rent them out. After we owned the property for 6 months we could get a refinance based on the new appraised value of the property.  This worked like clockwork for a couple years.

We fully executed this plan 5 times, and 4 of the 5 times we were able to fully pay the HELOC back for the purchase price, closing costs, and rehab costs with the new loan proceeds.  This was fantastic.  The carrying cost was minimal.  Our average property had around $50,000 into it and we carried it for 6 months.  This is a total interest cost per project of only $750, or $125/mo.   I wasn’t too worried about $125/mo.

Having this essential “credit card to buy houses”  my eyes got big.  I wanted to buy everything because the interest cost was effectively a rounding error.

Where It Went Wrong:

In 2022 I bought our 6 unit apartment building, which cost $171,000.  Our down payment of 30% plus closing costs was close to $60,000.  Then we had to rehab all the units and common spaces.  We did these 1 at a time, but it took a long time.  We finished the last unit in the late Spring of 2023. Total rehab costs on this property have been over $60,000.

In late 2022 I also saw that inventory was greatly tightening and there were very few deals coming onto the market.  A 5 bedroom house with a giant garage for $35,000 popped up and I had to grab it. We started some rehab work on the property, but for the most part it sat until the summer of 2023 when we had time to work on it.  So at this point for those keeping score the total debt from these 2 properties is $155,000.

In the spring of 2023 a good friend of ours who is like a sister to my wife was in a bad situation and needed a place to live.  She was about to have a baby and was homeless.  Her sister was already living up here in one of our 2 bedroom houses and she has been looking for a 3 bedroom.  We found a 3 bedroom that would work for her, rehabbed it in like 3 weeks, and moved her in, then did some quick touch ups on the 2 bedroom and moved the sister in with the new baby.  This 3 bedroom house cost us $35,000 then another $6,000 in rehab costs.  The HELOC is now maxed out, pushing $200,000.

We also had several issues with rental properties during the year, which kept us from paying anything down on the HELOC .  We had a sewer drain replacement, a roof replacement, 2 furnaces, and a house completely destroyed by a tenant.

Unable and/or Unwilling to Refinance:

To make matters worse, the lending market dried up.   I wanted to refinance the apartment building, but I couldn’t get a commercial loan at all.  The banks stopped lending. I had a decent cash pile, excellent cash flow, and an 800 credit score, and the banks would not lend me money, even at 60% loan to value.

Interest rates also spiked. Even if I could get financing, the interest rates had increased drastically in the last 18 months.  Fixed rate investment property loans were now around 8% instead of 4%.

The most recent house might not appraise well for a BRRRR method because of its location. I felt that the appraisal risk was too high for that property.  The first house we bought that needed an extensive rehab wasn’t complete yet, so I couldn’t refinance that either.

So now, here I am in the summer of 2023 with $200,000 on our HELOC, interest rates are rising rapidly, and I can’t refinance any of these properties to increase liquidity.

Carrying Costs:

The interest rate on our HELOC swelled from 3% in the spring of 2022 to 8.75% by the summer of 2023.  $200,000 at 3% is $500 a month, which isn’t a big deal for 3 properties.  At 8.75% the interest cost is $1,458.  That check is painful to write each month.

An expansion in interest rates this rapid hasn’t happened in 50 years. The last time interest rates rose this quickly was when we went off the gold standard in the late 70s.  While this was not expected, it is also possible that interest rates could continue to increase, and having variable rate debt is really scary when increased borrowing costs are a possibility.  What if the rates doubled again and for the same debt I would be paying almost $3,000 a month?  This is possible.  Rates topped out at 21.5% in 1980.  It’s possible they could rise that high again.

Opportunity Cost:

With our Heloc maxed, we also were in an opportunity cost bind.  We were overextended.  We didn’t have enough cash to be able to move on any new properties if something great came up.  We also ended up in a tough situation when our son went to buy his first home.

A house down the street from us came up for sale at a steal of a deal for $58,000.  Our son had enough money for a large down payment and enough work history and credit to buy the house.  He put in an offer and got it accepted.  The problem came with the first lender.  When we talked to our bank, which we have gotten several mortgages through, the lending officer told us that due to the condition of the house, they could not underwrite the property.

We were looking at the potential of him either having to back out of the deal or need to pay cash.  At the time he had a total of around $16,000 in cash, so he would have a deficit of roughly $50,000.   Had our HELOC been empty we could have helped him get into the house, then refinanced it once it was finished, but we had no space in our HELOC .

The only real option for making this house happen with cash would have been for him to take out a 401K loan and for us to do the same.  Thankfully, he was able to get a loan through Rocket Mortgage.  This was however a rough point in time.  This was a major life changing moment for our kid and I was in a spot where I could not help because I got overextended on my HELOC.

Stress:

Having a payment of almost $1,000 more than you expect can greatly add to stress.  Being in a spot with no liquidity greatly adds to stress as well.   We’ve worked really hard on our finances for the last 18 years in order to be in a spot where we don’t have to worry about our immediate cash situation.  As a direct result of us using our HELOC for investing in real estate we had to worry about our cash position.  Not only did we max our HELOC and have interest rates triple, while not being able to refinance out any of the debt, we also did this while I was off work for the longest amount of time ever.  We had decided as a family to eliminate me travelling, which means that one season every 18 months I will have an employment gap of 8 to 9 months.  This gap for me fell Between November of 2022 and July of 2023. We were in a serious cash crunch for almost a full year.

Time Cost:  I ask myself from time to time, What if we hadn’t done this?  The whole Idea of pursuing financial independence is to get time back.  Well, I feel like I have folded a great hand.  I work seasonally for my primary job and typically have the summers off.  Every summer for the last 5 years I have been rehabbing houses.  5 years ago our kids were 15, 10, 7, and 5.  Now they are 20, 15, 12, and 10.  With so much focus being on building our real estate empire I missed out on having stronger relationships with our kids.  Had we not had the Heloc as a tool, we would have grown the real estate empire much more slowly and would have likely only done half the rehabs, and thus spent half the time on them.

The Reality: The Reality of a Heloc is that at the very root the loan is against your primary residence.  This is why banks are so quick to push HELOCs because they know most people will do just about anything to not lose their home.  This $200,000 of debt against my primary residence is against my home.  If I don’t pay it they can take my house.   In retrospect I would have been better off to have refinanced my primary residence with a new 2.75% 30 year interest rate loan when rates were that low.  I could have put all the cash from taking out the loan in my checking account and paid in and out of the account with each real estate deal I did.  This still would have been a loan on my primary residence for the purpose of investing, but at least the cost would be fixed.

Forced The Sale of Real Estate:

I’m all about holding real estate forever, however with our HELOC being maxed out and with no clear way to refinance out of the debt we were carrying, we decided to sell one of our properties.  We listed the 5 bedroom house we bought for $35,000 for sale.  We had put another $20,000 into the repairs on this house.  Unfortunately we had delays in the process of getting this house ready for market and we didn’t get it listed until October.  The house sat on the market through the slow winter months, and we finally sold it in March of 2024.  Selling this house allowed us to net around $100,000 in cash, which we put on the HELOC.  Reducing the monthly HELOC payment from almost $1,500 a month to $750 a month was certainly a big stress reliever.

I would have liked to have been able to keep this house.  This was a large 5 bedroom house with a massive garage.  This would have been a great house for one of our kids in the future.  But it had to go.

Our Path Forward:

For 2024 the goal is to use all of the net cash flows from our rental properties to pay down the Heloc.  With an estimate of $60,000 of cash income for this year, this would end the year with our HELOC at roughly $40,000.  We are also evaluating selling one of our properties in Benton Harbor City.  We have significant equity in all our houses, so this sale could potentially get the HELOC paid off.

Once the HELOC is paid off we will still pause investing in new properties.  Yes we have a paid off house and the ability to borrow $200,000 effectively means we can buy $800,000 of leveraged real estate with it.  This however is not the path we need to take.  I want our paid off house to be a paid off house.  I don’t want our home to be at risk of anything.  I certainly don’t want to be paying almost 9% in interest to further building a real estate portfolio.  After we pay of the HELOC we will build a strong cash position, and future investments will be made from that and not from the security of our home.