Hello and welcome to another episode of Ask Marco where I answer your investing related questions.
Before I get to today’s question from Jason, I just want to remind everybody to smash that subscribe button. Remember to subscribe to the show so you never miss an episode. And that way I can continue to put these out and you won’t miss a great question from listeners like yourself. So I hope everybody is doing well and not going stir crazy with the crazy times that we are living in right now. So I will continue to do these episodes. And today’s question comes from Jason. He says, dear Marco, we are looking to take out a HELOC, a Home Equity Line of Crediton our primary residence for the purpose of buying our next home. And I assume he meant property here. Since I am a licensed residential contractor, I would like to find a new construction opportunity or a fixer upper fixer property.
To renovate with the plan to refinance both of those properties into a conventional 30 year fixed rate loan at the end of the project. Currently we have around $80,000 available through a Home Equity Line of Credit and that’s assuming you have an 80% loan to value, which is typical and some cash. My question for you is two parts. First, would we be able to get better loan terms as a construction loan and he says here slash line of credit, which are really two different things through my business or would it be more favorable to finance this as a personal loan? I know a big part of the answer depends on the deal Credit, but any input you have is appreciated. Secondly, there are a lot of HELOC Home Equity Line of Credit products out there. What terms should we be looking for in a favorable agreement and are there terms we should try avoid? Thanks for taking my question, Jason.
Well, Jason, thanks for the question. Here’s my quick thoughts on this. You mentioned a couple different things, so you have a couple of different scenarios going on here. First of all, if you’re looking at a new construction, literally new construction, meaning you’re building from the ground up project, then what I suggest you do is shop around if you can find it today, I know a lot of lenders have tightened up, but these loans are still out there. See if you can get yourself a construction loan, either a construction loan, which is just one type of loan or what’s known as a CP loan, a construction to perm short for permanent loan, which means that you have one close but two loans. So it becomes permanent loan, a 30 year fixed rate mortgage at the end of the construction and that starts off as a construction loan.
That’s the better way to go if you can find it because it’s really one close and you go right from construction to perm. So if you can find that, fantastic, uh, that’s probably the best way to go if you’re doing new construction because you’re not going to be able to get other types of loans, like a hard money loan because there’s no existing property. So you really don’t have much of a choice there. It has to be some sort of construction loan unless you have the cash on hand, which leads to the second option. If you’re doing a fixer upper, if you’re buying a property that you intend to keep as a rental or a home and you want to finance that, then you’re going to need cash or you’re going to need cash and some credit, which can come from your home equity line of credit.
Sounds like you can do around $80,000 and you’ve got some cash on the side. That’s great. Assuming that’s enough, I don’t know where you are looking at these properties, but if $80,000 plus your cash is enough to buy, fix, and then refinance that property to pull your cash out and or repay your line of credit, then do it that way. That’s similar to what we call a Burr strategy. B, R, R, R, R, which is short for buy, renovate, refinance, rent and repeat. So that’s one way to go with a quote unquote fixer upper property. The other option which you may want to consider has harder or higher loan terms, but it is a sometimes a better way to go and that is a hard money loan. Hard money loan is simply a loan, short term loan, typically six months for the purposes of buying and fixing up a property and often it’s not going to be for every dollar that you need.
You’re probably going to need something in it and maybe 10% of your total cost. But the nice thing about hard money is the property is the collateral. You can draw from that in stages and you can get the work done without touching your lines of credit, your personal cash or having anything to do with your personal funds so you can keep it completely separate and you being a contractor, you probably already know this and you being a contractor, this should be a pretty simple thing for you to find fund and then of course fix and continue on with whatever your plans are and probably being a contractor you could probably get some discounts on the construction, the materials and whatever else. Now as far as the best loan terms, probably in this order, the HELOC, the Home Equity Line of Credit would be the first choice.
In terms of the cheapest terms, the business line of credit might be the second cheapest. My experience is that business lines of credit tend to be shorter terms and higher interest rates. Uh, even though they can still be interest only, they tend to be more expensive as far as the cost of interest. And then lastly are the hard loans. Those typically are the most expensive in terms of interest rate being anywhere from eight to 10%, maybe 12% or more. And sometimes you’re going to have to pay one or two points up front. So cash is the cheapest. Your Home Equity Line of Credit would be the second least expensive. And then onto other types of lines of credit, like your business line of credit as far as HELOC terms go the home equity lines of credit. And for those people listening that are not maybe too familiar with a HELOC and what it is, it’s essentially a home loan with a twist because it’s actually a line of credit.
But as opposed to a having a set loan amount, you can just draw upon it as needed when needed if ever. Some people actually just get line of credit on their principle residence and hold it simply for the use of emergency funds if and when they even ever need it. Some people never even touch it. But uh, the nice thing about a HELOC is that rates are typically low. They’re almost always variable. And the reason for that is because the rate is tied to the prime rate. So what you have is a margin that’s added to the prime rate and that gives you your HELOC interest rate. So simply figure out your interest rate by finding what today’s primary it is adding your margin to it and that’s what you’re going to end up having. The downside of a HELOC is that the rate is adjustable because it’s tied to the prime rate, which is not fixed.
It does fluctuate a, not radically, but it does change so it can go up and down and it could go up significantly during times of inflation. We haven’t seen that happen lately, but they are adjustable rates. It’s kinda like the adjustable rate mortgage similar to that. As far as interest rates go today, if you have good qualifying credit or even excellent credit, you can get a from many lenders in the five to five and a half percent APR range. So it’s, it’s very reasonable. It’s, it’s cheap. Money’s what it is. Now, I have seen banks advertise rates as low as two and a half percent and I don’t know if that’s a teaser rate, but I have seen rates from two-and-a-half up to 10% I think you’re probably going to find four and a half to five and a half percent with good to excellent credit today, April 22nd the average HELOC rate is 4.98% so call it 5% and that’s assuming you have good credit.
And the nice thing about HELOC is that you typically are able to draw from them for a full 10 years and you have up to 20 years to pay it back or pay it off. So you may end your ability to draw from it after 10 years, but it doesn’t mean it goes away. You could actually be repaying it for up to 20 years. So that gives you a very long repayment period. So there’s a lot of flexibility in having lines of credit, especially home equity lines of credit and the terms are all over the board. So, I suggest you just shop around, check out maybe two or three mainstream or large banks like Wells Fargo, bank of America, fifth third bank, chase bank, and maybe some credit unions and some other smaller boutique banks. And that will give you a very, very good understanding of what’s out there.
Last but not least. I just want to quickly touch upon this business lines of credit might be advantageous depending on the type of business you have and if you need to make deductions off of that interest and if it even qualifies. Talk to your tax advisor about this, but my experience, I’ve found that business lines of credit typically have higher, not always, but higher interest rates, shorter terms, sometimes only as much as five years and often lower loan amounts because they’re really relying on the success or lack of failure of your business as opposed to collateral like a piece of real estate which is more favorable to a business. The real estate will probably be there 10 20 years from now. Many businesses fail in the first one to three years, so nobody knows if your business is going to be around in five or 10 years. All right, so that’s what I want to say about HELOC in lines of credit.
In wrapping up, I’m going to just give you some tips. Run your numbers carefully, especially if you’re doing a fixer upper and if you’re buying a piece of property that needs some work, pencil out your numbers very, very carefully. Double check your numbers. It’s easy to make mistakes or to forget something. Make sure you build in contingencies for things to go sideways wrong or things to go South. You will uncover other problems as you start doing your work. For example, I’ve had properties where we thought everything was fine and then after we started construction or work and renovation, we found out that the foundation was cracked and that was like a five or $10,000 fix. So things can creep up into your projects that you don’t anticipate or expect. So always add at least five to 10% as an overall contingency, but also be very thorough in what you are trying to accomplish.
Last but not least, make sure you add a profit. I think a lot of quote unquote investors, basically flippers and rehabbers don’t actually put a profit margin in there. Whether that’s a minimal 5% 10% 15% put something in there. And that could be your equity. If you’re putting in the sweat to turn that into equity budget that in, make sure that you have that equity there, whether it’s um, you know, a percentage of profit because you’re flipping the property or because you just intend to keep it because ultimately you’re going to want some equity in there, especially if you are refinancing this property to pull your cash out or repay your HELOC. So this is not the typical question that I see because most people we work with are buying hold investors. They tend to buy something that’s rent ready or turnkey so they don’t have to go through this process of fixing up anything.
In fact, it’s about as passive as you can get short of buying stocks in a real estate investment trust. But anyway, those are some comments. Jason, I hope that is helpful and good luck with your project. Uh, so for everybody else, if you’re listening to this and you have a question about investing real estate related or otherwise finance, great, just send that over to me. Go to AskMarco.com click on the Ask Marco button, send your question in and I will try to get that to you as soon as possible. Help us share the show with other likeminded people. Share this show with your friends and family. Visit us on iTunes, leave us a rating and review. We would love that. Thanks for listening and I will see you on our next episode.
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