What is home equity line of credit or HELOC?
If you have used a credit card, you'll easily understand the concept of the home equity line of credit or HELOC. In simple term, a HELOC is a revolving credit, like the credit limit with your credit card. The difference is that a HELOC uses your home's equity as a collateral. Basically, it's a credit card secured with your home's equity.
How to use your HELOC to pay off your home loan super fast?
The nice thing about a HELOC compared to a regular loan is that once you pay down the balance, you'll have more money to use again. You can keep using the line until the end of the draw period, which is usually 10 years. At that time, you can either pay off the remainder balance with a balloon payment, or refinance into another HELOC or home mortgage.
The advantage of the HELOC over home mortgage is that a HELOC uses simple interest, so you can pay down your home A LOT sooner than the standard 30 years AMORTIZED home mortgage.
Let me give you my example. I had a $247,000 home mortgage with 4.25% interest rate. Not bad right? I was paying about $1,300 per month to the bank. Of the $1,300, about $900 is interest charge. So only about $400 goes to pay down my principal, about $4,800 in a year.
I later applied for a HELOC of $250,000 to pay off my existing $247,000 home mortgage. My HELOC has an introductory rate of 1% the first year. If I continue paying $1,300 a month, I would have paid off $13,200 in principal in ONE YEAR because my monthly interest in now only $200 a month.
The best of all, the HELOC acts as my emergency fund too. As I pay off more of the balance, more money is available to use.
And what is home equity?
Home equity is the the difference between what your home market value and the total home loan you owed. For example, your home is now worth $1 million, but you have a home mortgage of $300,000. So in this case, your home equity is $700,000.
Most banks do not let you borrow 100% of your market value. The most I've seen are 90% and 95%.
How much home equity line of credit can you qualify for?
The qualification is very similar to qualifying for a home loan. You still have to show proof of income, good credit score, appraisal, etc. The general rule to figure out how much you qualify for is 80% of your home market value minus your outstanding mortgage.
We'll use the same example we used earlier. So your home is worth $1 million in the current market. 80% of that $1 million is $800,000. We then subtract your current outstanding mortgage of $300,000. Therefore, you qualify for up to $500,000 in HELOC, given you meet income and credit score requirements.
How do you use a HELOC to expand your real estate empire?
We hear a lot about using other people's money (OPM) in investing in real estate. A home equity line of credit is one of these strategies. Technically, it is still your money, because it is your equity that you're using.
So in the previous example, you qualify for a $500,000 HELOC, which you can use to buy a small rental property all cash. Or you can buy a multi-dwelling rental properties all cash too. The rental income that you generate, you use that to pay back the HELOC. Since you purchase these properties with all cash, which means you have instant equity in these properties. Then you can take HELOC again out from these properties and repeat the steps of buying more rentals or fix and flips, whatever your mean of investing is.
Isn't this brilliant?