Last week I was listening to a BiggerPockets podcast and their guest was Clayton Morris from Fox & Friends Weekend. I’ve never seen the show and didn’t know who Clayton Morris was, but it was actually a very good podcast. Clayton’s one of those guys you can tell just by listening to that he’s extremely intelligent and the show was very entertaining as well. After I was done listening, I found his blog online and that led me to an interesting article he posted a while back – “How to pay off your house within 5 years using these awesome ninja tricks.” It involved using a Home Equity Line of Credit (HELOC) to make this happen.
I re-read it a few times and I was thinking that it might even help me in paying off my residence. I mentioned it in conversation when talking with one of my financial mentors the other day and he didn’t give me a yes or no on this, but then he mentioned something real quick that I didn’t think about until later. He said that I should look at if it would make sense to open up a HELOC to pay off my rental house.
I had never thought about that until that moment, but it did get the ol’ noggin’ ticking…
Right now I owe around $35,500 on the rental house and the tenants have paid the majority of the mortgage to get it down that far. I do pay more than the minimum and I’m scheduled to have it paid off in about eight years. When I got the loan back in 2003, I got a 30-year mortgage at 5⅛% which was a pretty good rate at the time. The bank had also previously got slapped on the wrist for breaking the law and was required to cover PMI on new loans, so I didn’t have to pay that either – what a deal!!
So, would it be worth it to get a HELOC to possibly save some money? Let’s find out!!
First off, why not a home equity loan instead of a line of credit? Well, the interest rates are generally higher than HELOCs because you generally get the “privilege” of a fixed rate. The equity loans also require you to pay for closing costs (escrow, title, and recording fees, etc.). A HELOC, on the other hand, usually has lower upfront costs and doesn’t require a formal closing. So I’m going to focus on the HELOC because I think it might be better for my needs with this.
My residence right now has about $97,000 in equity based on Zillow’s current valuation (which is never right, but at least gets us in the ballpark). Most HELOCs I’m seeing right now will let you an 80% maximum loan-to-value (LTV). In other words, you can take the amount of equity you have in your house and multiply it by 80% (or 0.80) to get your 80% LTV. In this instance, $97,000 x 0.80 = $77,600. This is waaaaaaay more that I need, but it’s good to know that I should be safe in getting the line of credit I would need.
From here, there are a couple of options. Some HELOCs have a special introductory rate that goes up after the specified period of time is up. However, these are just teaser rates and might only be for 5 or 6 months before the rates go up a pretty penny. If I was going to be paying this back in a much shorter amount of time (say a couple of years), this might be more important and helpful. The other option is a HELOC without any intro rate and that seems to be the best choice for me based on the duration of payback since it will cost me less over the long haul. As a side note, a good place to get a feel for rates for yourself is on bankrate.com.
Now, if I pay off the loan on my existing mortgage for the rental house, I lose the interest deduction come tax time obviously. On the flip side, the interest on a HELOC is usually tax-deductible for loan amounts up to $100,000 for home purchases and improvements (I’m thinking this would qualify). If so, this would be a wash which is definitely Ok with me.
For our purposes, I’m going to look at using my credit union for the HELOC since their rates are generally lower and I despise the big banks anyway. My credit union is currently offering a 3.5% variable rate. Based on that number, if I kept my same payment, I could get that paid off in seven years… that’s one year sooner than it would take with my current mortgage!!
Sounds like a winner, but…
The biggest problem I have with this scenario is that it’s a variable rate. Paying this loan off in seven years as I mentioned previously is under the assumption that the rate doesn’t go up… but it will. I don’t know how much the rate will go up, but I need to assume that it’s going to go up a decent amount. And I’m the type of guy that really likes that fixed rate… the “known” makes me comfortable.
So is this idea worth the risk?
Possibly. I really want to get my rental house paid off faster because that would give me additional cash flow sooner that I would be able to put toward the mortgage on my residence. And, even if the rate would go up .5% per year, it would still only tack on about another 4 months to my payoff, which would still be 8 months less than my current mortgage.
But boy that variable rate is just rearing its ugly head saying “I’m gonna get you, sucker!!”
I did find one benefit though – I sent the idea over to my new accountant and he’s going to give me some feedback… I’m really starting to like this accountant thing!
Do you think I should go after this and have any of you ever considered using a HELOC for paying off another property?
Thanks for reading!!
12 thoughts on “Should I Use a HELOC to Pay off My Rental House?”
Very interesting concept. But I personally never think it’s a good idea to borrow money from something else to pay off another thing…especially your main residence. You’re really in the same boat just paying a different bank. With that said, have you considered refinancing the rental with a lower fixed interest rate conventional loan? You should be able to do that if you have 20% equity in the rental. I know how you feel…we have two rental properties that I’m itching to get paid off quickly too.
Good to hear from you!
I’ve looked into doing a refi on it, but the biggest problem is usually the closing costs. When you factor those in, it didn’t make it worthwhile for such a relatively small amount of debt. The other problem is that with it being a rental, the interest rates are a little higher than it would be if it was my residence.
I do agree that I’m just shifting my debt from one place to another, but as long as I’m not adding to it, it seems like it makes at least some sense to be able to get it paid off faster. I just heard back from my accountant and he wants to discuss this idea with me tomorrow, so I’m interested to hear what his opinion is on it.
I tend to agree, but I think you already know that I’m not nearly as comfortable with leverage as you are. 🙂 And we were too scarred by the 2008 crash and all the people that lost their homes because of HELOCs to even consider them. But that’s definitely an emotional argument, not a financial one! For me, it would come down to simplicity — do you have time and brain energy to devote to this switch, and is it worth whatever small amount you’d save? If yes, then great, go for it. If no, then keeping things as-is will give you one less thing to worry about, which might be well worth the small difference in interest payments.
Hi ONL – the good news is that this isn’t going to involve much to switch over to. In fact, I now have the process rolling. They’re going to do a drive-by appraisal (much better than the other kind of drive-bys!) and then we’ll just go in and sign the paperwork. It’s almost like opening a new bank account. Then I’ll write a check from the account to pay off the mortgage on the rental and it’s done. Future payments I make will just go toward the debt on the HELOC instead of the old mortgage. It should be pretty simple and if I can shave a year (or close to it) off of my payoff, it sounds like a good deal to me!
In that you are leveraging your primary residence, I would say as long as you’re comfortable with the total debt (including the HELOC) on that primary residence, you should be fine. And it doesn’t sound like this will put too high of a leverage ratio on the property.
As far as rates, who knows. The fixed rate is pretty low, so it’s hard to see it going anywhere but up, but that’s what I thought when I refinanced at 4% two years ago. If the variable rates starts trending up, you can refinance your primary and HELOC into a fixed rate loan if that makes you more comfortable.
Thanks, FS – I was thinking the same thing if the rates start climbing too much. I talked to my accountant today and he thought it was pretty much a no-brainer, so I’m going to roll forward with it. If played right, hopefully “little” changes like these can play a small part in pushing up my FI date.
I read this post on Friday and then solidly looked into it for a few hours. I really like the idea of sending every last penny toward the mortgage while not worrying about overdrawing (because it’s actually a loan). But it really only makes sense if the HELOC rate is lower than the mortgage rate. And that’s not true for us. Our mortgage is 3.675 and the HELOCs are over 4.
You’re absolutely right that it only makes sense if your HELOC rate is lower than that of your mortgage. For us, we’re in a unique position where our mortgage on the rental is actually a lot higher (5.125%!!!). In a lot of cases a refi, might be an option as well, but we have some other circumstances with this house making that a little more complex. However, the HELOC will actually save us on closing costs and will probably put us in a much better position anyway.
I really like the idea of using the HELOC this way. I like the flexibility the most. I read Clayton’s post and a few others on the process.
I was planning to use a HELOC on my primary residence to pay down my debts and then to do home repairs, but I didn’t qualify. The flexibility would have allowed me to pay off debts as I increased monthly cash flow, moving to each new debt as I paid down the HELOC each month with my net income…basically Clayton’s method. Instead, I applied for a cash-out refi on my house to pay off significant debt and increase monthly cash flow, but it’s only a one-time event with no further flexibility.
Either way, I pay off significant debt, so that’s good.
With rates being so low, that definitely sounds like a no-brainer! 🙂
Hi Jim! I’m on the exact same situation that you were here in 2016. It is now 2021, please tell me how did it go? I agree with everything you wrote; however, with the current tax law I don’t think the interest on the HELOC would be deductible. Another thing is my rental interest rate is 5% fixed, my HELOC 4.4% variable. I assume it will cost me more if I lose the deduction BUT I really would enjoy the flexibility to pay off the principal at a faster rate and immediately lower the monthly HELOC payments vs the current 30 year fix loan where extra payments don’t make a difference in the amount of interest I pay next month.
Hi Diego – we did use a HELOC to pay off the property but we ended up selling it a couple of years later for other reasons.
I can’t give out financial advice since I’m not a certified professional, but I can say that using the HELOC worked well for us while we owned the property. Best of luck!