3% mortgage rates have chained us to our homes. If you bought a house or refinanced in the pandemic you’ve probably been enjoying a <3% interest rate. Your monthly mortgage payment is the lowest it's ever been.
But is your home actually a bit too small?
You might’ve added a kid to your family throughout the pandemic. Perhaps you rescued three dogs. Perhaps you impulse-purchased a home in rural South Jersey while remote working and now your Philadelphia-based office wants you back.
Reluctant to sell their house and lose that 3% interest rate, many families are now becoming “accidental landlords”. I.e. buying a new home, while keeping the 3% home and renting it out to a tenant. Let’s talk about how you can do this.
📮 RELATED POST: SHOULD YOU RENT OUT YOUR HOUSE WHEN YOU MOVE?
The HELOC
Most homeowners aren't sitting on tens of thousands of dollars of cash to buy their next home. Luckily, one of the perks of getting on the property ladder is the equity accrued in that house. Home equity gives you many options, and you can put it to work by using a HELOC.
A HELOC, which stands for Home Equity Line Of Credit, is pretty much exactly as it sounds: it is a line of credit available to you (like a credit card) based on your home’s current equity.
It is one of the most flexibility options available for you to access your equity; once the mortgage lender establishes how much equity you’re allowed to withdraw, the funds ‘sit’ there until the time you need it. The benefit of this is that you’re not paying interest on the cash until you actually put it to use. As such, a HELOC is divided into two pay periods: the draw period, and the repayment period.
👍 Pros of using a HELOC
- Flexibility: HELOCs offer a flexible way to access cash, only borrowing what you need, when you need it.
- Lower interest rates: Typically HELOCs have lower interest rates compared to other loan types, making them a more cost-effective option.
- Tax benefits: The interest you pay might be tax-deductible if used for home improvement.
👎 Cons of using a HELOC
- Risk of overleveraging: Borrowing against home equity can be risky if property values dip, leaving you in a negative-equity situation — which is also why most HELOC products cap the amount of equity you can pull out of your house.
- Variable interest rates: HELOCs usually have variable rates, which means your payments can increase over time.
- Additional debt: It’s essential to remember that a HELOC is a loan that must be repaid, adding to your debt burden.
👱♀️🔍 Seeing A HELOC In Action
To help you visualize how a HELOC could work in your situation, let’s look at clients who have used one: Alex and Jordan, a couple from South Jersey, purchased their first ever home for $140,000 in 2016. Their house had served them well but with only 2 bedrooms, 1 bathroom, and a small yard, they were ready to upsize.
As you can imagine, over time with them paying off their mortgage on top of the significant home price appreciation we’re seeing in South Jersey, their home was now worth a lot more. In fact, after speaking to a mortgage lender about a HELOC and getting their home appraised, the couple found out the home was worth $270,000.
They’d paid off about $50,000 of their mortgage principal over the years and, with the added appreciation, they were sitting on over $180,000 worth of equity!
After opening a line of credit for $100,000, they started their house hunt for a larger home. Their goal was to find a 3 bedroom, 2 bathroom home, and put down around $40,000 of a downpayment, while having plenty of cash leftover for:
- closing costs
- any immediate decorating they wanted to do to their new home
- updating their existing home by painting all walls a neutral color, upgrading the tired kitchen cabinets, and hiring a professional cleaner to ready the place for rental
Upon closing on their dream home, Alex and Jordan ensured they kept a strict budget so they could pay off their HELOC rapidly. With the South Jersey rental market being the way it is, the couple were able to rent out their previous home that same month, and now enjoy a profit of $1,000 of the rental income after paying off the mortgage every month. They split this passive income between putting it in an emergency fund, paying off their HELOC, and paying extra towards their new mortgage.
Work With Pros
As mentioned above, HELOCs can be risky as well as rewarding. Using a HELOC is a strategy that requires careful financial planning and market knowledge.
Every situation is unique, so you may want to consult with a financial advisor to understand if this strategy aligns with your financial goals, and ensure you work with an expert real estate agent who understands the local housing market (rental AND purchase!).
