Rookie Reply: How to Use Home Equity to Buy Rentals

Ashley:
This is Real Estate Rookie, episode 196. My name is Ashley Kehr, and I am here with my co-host Tony Robinson.

Tony:
Welcome to the Real Estate Rookie podcast, where every week, twice a week, we bring you the inspiration, information and motivation you need to kickstart your real estate investing career. I love Saturdays because we get to switch things up a little bit. Right? We get to dive into some of these questions. But before we do, Ashley, just tell us what’s new with you. What’s going on? What’s new in your neck of the woods?

Ashley:
Not much actually. The last couple of episodes we talked about my knee surgery. We talked about a new deal I’m looking at. So yeah, really nothing else new that I can think of. What about you, Tony?

Tony:
Yeah. For me, we actually just lost out on a property. It was in a new market that we’re looking at and we put up $20,000 as our EMD and with everything that was going on, it’s new construction and the way they set it up was that you had to get a loan to purchase the land and then you had to get a secondary loan to cover the construction. So it was really weird how they had it set up, but with everything we had going on, we totally dropped the ball on remembering that we needs to get this financing for the land because we got this under contract, I don’t know, maybe seven months ago and now it’s like, “Hey, it’s time to start.”

Tony:
It was this mad ground to try and find a lender, but the lender that the builder recommended didn’t want to lend to us because they said that we were overexposed for short-term rentals in our portfolio. They’re like, “This is for someone that this is their first short term rental X, Y, Z,” and it was really weird. We went to three different lenders in that same city and they all said the same thing, but I guess what’s happened is that in that town, in that region, there’s been just this boom of new construction of short term rentals. So I don’t know why, but I guess they feel that there’s less risk lending than someone that doesn’t already have short term rentals. In my mind it would be the other way, because if you have short term rentals, you know what you’re doing.

Ashley:
You have experience, yeah.

Tony:
Anyway, we ended up having to back out of that deal because we couldn’t get the financing in time for the construction start date. Now we’re possibly going to lose our $20,000 EMD, so we’re going back and forth with the builder to see if we can get it back from them.

Ashley:
Okay. Well, first of all, that’s awful. That’s a lot of money to lose, but can you tell everyone what an EMD is? Your earnest money deposit. Explain that, how that process works and why you might not get it back.

Tony:
Yeah. So thank you, Ash, for asking that question. So your EMD stands for your earnest money deposit. So a lot of times when you look to purchase a property, the seller will ask for an EMD, or an earnest money deposit, to show that you have in … even though you’re … let me take a step back. Plenty of people can submit an offer on a property, right? But some people are tire kickers. Some people just want to lock the property up to see what happens. So a lot of times sellers will ask for an earnest money deposit to show how serious you are as a buyer. The way that it works is the earnest money deposit is whatever amount you and the seller agree to. Could be as low as $100, it could be as much as $20,000 or maybe more, and That money gets deposited into escrow.

Tony:
So the seller doesn’t have access to those funds. It’s held in escrow. Then typically there’s a certain point in your contract where your earnest money becomes non-refundable, which means that if you back out of the deal, for any reason, you don’t get that money back to you. It actually goes to the seller. But if you cancel before that date, then you as the buyer get your earnest money back. So we are in a situation where our expiration date for the earnest money deposit passed. So it was considered hard, right? So your money goes hard, your EMD goes hard after that expiration date. So now it’s really up to the sellers to decide if they want to be nice or not, or if they just want to keep our $20,000.

Ashley:
Yeah. I recently did a $50,000 earnest money deposit on a property. They originally wanted $300,000 as the earnest money deposit.

Tony:
Isn’t that crazy?

Ashley:
So we settled on a 50 and what happened was it was a bank that was selling this property and they just wanted to push, “We want this a quick close,” blah, blah, blah. So they’re like, “We won’t accept any more than 30 days due diligence. No more than that.” This was a massive property with so many different avenues. So what my attorney did when he structured the contract is he said, “Okay, the 30 days actually starts when you send us the title work.” So that way it actually gave us so much more time. We ended up taking two months and we still had more time locked because the bank’s attorneys just took so much time to get the title work done and sent it to us.

Ashley:
Then ended up backing out that deal because of multiple issues, but we were able to get our deposit back pretty quickly. That was such a key thing that my attorney did was put in these little loopholes where it’s on [inaudible 00:05:16], “Yeah, we’ll take 30 days due diligence, but that time isn’t going to start until we have all of the information we need to actually understand the property.”

Tony:
Yeah. We did something similar for our Big Bear hotel where we set it up to where the due diligence period didn’t start until we got all of the financials back from the summer. So that ended up giving us an extra, I don’t know, I think 14 days or something like that. So there’s some ways you can structure it. But same for us in that deal, we put up $50,000 in EMD as well and that went hard a little over a week ago. So now for whatever reason this Big Bear dude doesn’t work out, we’re out 50 grand. So we’ll see.

Ashley:
It will, though.

Tony:
Cool. Fingers crossed. We’re making good progress. Awesome. But today’s question actually comes from my DMs and if you guys ever want to get your question featured on the show, you can go to the Real Estate Rookie Facebook group, the Bigger Pockets forms, or you can slide in mine and Ashley’s DMs. We pull questions from all those places. But today’s question, I actually don’t know who this came from. So I apologize in advance if you hear this question and it sounds familiar, because I just took a screenshot of the question, but I forgot to get the person’s name. But it says, “Hi, Tony, I need your advice. I have a good chunk of equity on my home. Do you think it’s why to pull some cash from my home to purchase an investment property? If not, what do you suggest I do with that equity?” Ash, why don’t you kick us off here? What are your thoughts on this equity piece?

Ashley:
Okay, well we know interest rates are going to raise two more times this year. So if you are going to pull any money out, now is the time to do it. So you basically have two options. The first option is you can actually go and remortgage. Get a whole new mortgage on your property. So I would look at what is the current interest rate on your mortgage now. Can you get a lower interest rate if you go and refinance right now, or is it going to be higher? So if it’s going to be in higher interest rate, don’t remortgage, keep the mortgage that you have on the property. Then look at a line of credit. So pulling out a home equity line of credit on your property. Since it’s your primary residence, you’ll usually get good terms, a good interest rate. Some banks will actually do a promotional period where maybe for the first six months, the first year you’re only paying 1.99% or 2.99% on that money for those first six months and then it actually goes variable.

Ashley:
So I would definitely look into a line of credit or to remortgage and refinance and pull that money out. I think it also depends what you’re using the money for too. So if you are going to purchase property and you’re maybe going to flip it, so you’re going to make your money back right away, or you’re going to bur it where you’re going to go and refinance that money and pull it back, then you want that line of credit so you can just pay the line of credit back and then you got that money again to go do the next deal. But if you were looking for a down payment maybe, or maybe you’re looking to just purchase a property in full and with no expectation of going and refinancing anytime soon, then I would go ahead and remortgage the property instead of pulling out that line of credit.

Tony:
Yeah. Ashley, I think you hit everything, just like the nail on the head with everything you said. I probably wouldn’t refinance in today’s environment, assuming that you have a better interest rate. I know for us, when we bought our primary residence, 3% was our interest rate. If we tried to refinance today it’s two and a half points higher. So it wouldn’t make sense for us to refinance our mortgage. So I think your point of if your plan for the capital is something that’s short with a quick turnaround time, like flipping, then a line of credit probably makes the most sense. Honestly, that will probably be my approach right now anyway.

Ashley:
You can get a better loan to value too, because a lot of times they’ll lend you up to 90%, 95% of the loan value. So say your house is worth a 100,00 and you have a mortgage of 60,000 on the property already. They’re going to give you a line of credit for that other … what is that? 35,000? The math right? 35,000, give you a line of credit up to that 95% loan to value. So that’s definitely an advantage too, is that doing a line of credit you’ll be able to pull more money off. You can also do a home equity loan where you’re actually pulling the money out, they’re going to amortize it for you over so many years, you’re going to get a fixed interest rate and then you just make those monthly payments.

Ashley:
So it’s almost like a second mortgage on the property where the line of credit, the money can just sit there on the line, you can pull it off as needed and you’re only paying interest when you use it. Then if you pay the money back, the money is still there for you to pull off at certain times. So you just have to watch when that line of credit expires, when the bank can say, “You know what? We’re actually closing down your line of credit.” I remember during COVID, a lot of people started pulling all their money off their lines of credit, afraid that the banks were going to shut them down and close them off. So they were trying to pull their money off before the bank said, “You no longer have access to this money.”

Tony:
Yeah. Ashley, I think you literally said everything that I was going to say, so I don’t, I don’t think I have a whole heck of a lot more to add. Again, sorry that I didn’t grab your name, but hopefully whoever asked this question, we gave you a good response and now you’ve got some ideas or at least some flexibility in terms of what strategy you can use with that equity you have sitting in your home.

Ashley:
Tony, usually if I pull someone from my DMs, after we record I’ll send them a message saying, “Just so you know, your question was answered on this episode.” So you can send that to them so they can watch you forget their name.

Tony:
I apologize in advance.

Ashley:
Thank you guys so much for listening to this week’s Rookie Reply. I’m Ashley @wealthfromrentals and he’s Tony @tonyjrobinson and we’ll see you guys on Wednesday.