First Rental Property

Question: Most down payments come from secured line of credit or sometimes called HELOC, the question is do investors pay down the loan or leave it? 

Answer brought to you by Aneta Zimnicki:

Using a secured Home Equity Line of Credit (HELOC) as downpayment for investment property is a great sophisticated investor strategy.  You essentially are borrowing money to make more money, your return on investment is infinity, a true ‘zero down’ scenario.   You may know people who have a psychological barrier about debt in general, and are keen to erase debt, no matter what kind. But if the cost of borrowing is less than the income it produces, why would you not want to use it?  

So, is it worthwhile to pay down the HELOC? Let’s look at some math.  Typically today, you can see a HELOC at prime(3.0%) + 0.5% or prime +1.0% and, typically payments are interest only.  At 4.0% for example, $10K will cost you about $33/m. If you properly acquire cashflowing properties, this cost of the interest only HELOC is covered and most likely, you have extra income left over.  No need to be subsidizing the loan, it pays for itself.  Also, the interest cost is tax deductible (because the funds are borrowed for investment purposes), bonus!  For these reasons, savvy investors do not have any interest (pun intended!) in paying down their HELOC.  

The cheapest way to fund a downpayment is always cash, it is always best to exhaust that first before moving into HELOC usage.  You want your money working the hardest for you.  But you also want to find out, during your mortgage planning stages, if you can carry the HELOC loan for your future purchases, it is a delicate balance between income and debt service.  A mortgage broker who specializes in investment property mortgages, such as yours truly  :o)  can help you with the big picture. 

Some HELOCs are standalone, and some are bundled within a re-advanceable mortgage. For the re-advanceable product, every dollar in principle that is paid down in the mortgage is accessible on the HELOC side.  Usually the mortgage is a pretty competitive rate and the HELOC is slightly higher rate.  Paying down your re-advanceable mortgage aggressively with extra cash you may have acquired makes most sense if your mortgage is at a high interest rate otherwise, why not just use the cash for a downpayment for your next income property?  Consider your re-advanceable mortgage like a cheap loan. 

Another good use for your cash is to pay down your consumer debt, such as credit cards, unsecured lines of credit and car loans. That debt and interest is not tax deductible and eats into your debt ratios. It simply does not make sense to chip away at a 3.5% HELOC if you have colossal loans elsewhere.   

For tax purposes, it is highly recommended to keep personal and investment portions of a HELOC separate, ideally in separate accounts.  In this way, you can prove clearly to the tax authorities what your cost of borrowing is for investment.  If you have one of those HELOCs that is one account only, you may want to keep a portion of your accumulated cash in savings rather than paying down the HELOC. Because, if you sunk that money in and then draw it out later for your personal use, you tainted your accounting system. From experience with my clients and feedback from my accountant who works with many real estate investors, the tracking of interest in this situation is abysmal and you open yourself up for scrutiny and audit.  Not worth it, in my opinion! 

As a real estate  investor who is starting out, your goal is probably building up a portfolio.  In this phase you will be using debt to help you fund your portfolio.  There will be a day when your goal shifts to retirement income from your investment property, then paying down mortgages and HELOCs is appropriate in this case, to maximize your income.   

Aneta Zimnicki is a passionate real estate investor and mortgage agent, specialising in investment property mortgages.  You can check out her website My Mortgage Sherpa for more information.