WEALTH BUILDING & LEGACY
LINES OF CREDIT
REAL LIFE EXAMPLE B elow is real life example of how one of our clients recently got started in the rental business with a line of credit. The investor has a $60,000 HELOC, which means a bank has loaned the investor $60,000 secured by a second mortgage on the investor's personal residence (i.e., the equity in the home). A fewmonths ago, the inves- tor found a $48,000 property to purchase (see image below). After borrowing the purchase price from the line, the investor used another $10,000 against the line to make re- pairs to the property.
BENEFIT #2 - FREE AND CLEAR PROPERTY Using a line of credit allows an investor to purchase a property without a mortgage, since the line of credit is usually secured by another underlying asset. This is a benefit because the property purchased on a line of credit is owned "free and clear" of a mortgage, which allows the property to be easily sold or financed at a future date. USING CREDIT RESPONSIBLY INCLUDES KNOWING THE DISADVANTAGES Although there are many reasons to use a line of credit, there are a few disadvantages. First of all, when you use a line of credit, you have to pay interest. That adds to the total cost of the property. Be sure to factor in the cost of interest in a worst-case scenario when you are deciding whether to use credit to do a deal. Remember, nothing is 100-per- cent predictable, and you need to have a strategy for dealing with unexpected delays and the associated interest. For example, in my opening case study, I had several alternative plans ready in case I was not able to obtain that long-term mortgage. First, I would have started paying the interest due every month on the credit card, leaving the principal balance outstanding. Second, I would have made addition- al monthly payments to reduce the principal while continuing to look for a permanent mortgage for the property. In a worst-case scenario, I would have
4. PERSONAL UNSECURED LINES These lines of credit are similar to credit cards and usually offered to high- ly creditworthy individuals by retail and commercial banks. Most people who obtain these lines have some combina- tion of excellent credit scores, a long personal history with the lending in- stitution, extremely low or no personal debt, and a high net worth. 5. CASH-SECURED LINES A cash-secured line is similar to a per- sonal unsecured line except a borrower has to put up a cash account, usually dollar for dollar, at a financial institution as collateral. For example, with a $50,000 certificate of deposit (CD), a bank would give a customer a $50,000 line of credit secured by the CD. 6. MARKETABLE SECURITIES PLEDGED LINES This type of credit line is essentially the same as a cash-secured line except the collateral is in the form of stocks or bonds. Unlike a cash-secured line, which is 100 percent loan-to-value, these lines are approximately 50-cents- on-the-dollar because securities fluctu- ate in value so frequently. Conventional wisdom (and a lot of financial-help gurus) advise real estate investors to steer clear of using credit. They warn that you might end up over your head in debt. However, if you are responsible and strategic with your credit lines, you can experience great success. In my experience, investors derive two major benefits from having a line of credit: BENEFIT #1 - QUICK CASH A line of credit serves as "dry powder." The old saying that "cash is king" is still alive and well in real estate investing. Having a line of credit allows an investor to offer sellers a quick cash close, which frequently lands the deal (compared to financing a purchase through conventional borrowing, which can take months to complete).
Using Credit Creatively and Responsibly in Real Estate CREDIT CAN BE YOUR KEY TO INVESTING SUCCESS, BUT BE CAREFUL.
At that point, our client was
"all in" at $58,000, but did not owe any
money against the investment property since the money was borrowed from the line, which is secured by
by Douglas Skipworth
I
usually require that these loans are short-term in duration. However, it is good news for borrowers that lenders almost always renew the lines at maturity of the loan if the borrower has upheld their end of the bargain. 2. CREDIT CARDS Credit cards are issued by a financial company and give the borrower an op- tion to borrow funds up to a maximum amount determined by the credit card company based on credit scores, income, and payment history. 3. HOME EQUITY LINE OF CREDIT (HELOC) A HELOC is a second mortgage on personal residences that offer access to the owner's equity in the home.
do using that credit to leverage this strat- egy successfully. First, understand your options: 1. LINES OF CREDIT A line of credit is simply a maximum loan amount that a lender has com- mitted to a borrower over a specified period. The borrower can usually access the loan amount repeatedly during that time as long as the borrowed funds are repaid according to the terms of the loan agreement. For example, if I have a line of credit of $50,000, use all of it, and then repay $23,000, I can borrow up to $23,000 again if I need it as long as I’m in good standing with the lender. Because lines of credit are very flexible and beneficial for borrowers, lenders
once used a promotional “ze- ro-percent-interest-and-ze-
ro-points" cash advance feature on my $25,000-limit credit card to buy a $25,000 property. Then, I refinanced it with a local community bank at 100 per- cent loan-to-cost (75 percent loan-to-ap- praised-value) within six months, right before the initial interest free period expired. That credit card line of credit allowed me to purchase a property, have it fixed up and rented, and mortgage it with a long-term loan without my actu- ally having $25,000 in cash on hand. This makes credit cards and real estate sound like a great combination, right? Yes, it does. But you must understand everything about your personal credit situation and the deal you are going to
the investor's primary residence. Since the property was mort- gage-free, the investor went to the same bank and got a 75 percent loan-to-value loan (the house appraised for $77,000) against the house. The borrower used the $58,000 proceeds from the bank loan to repay the line of credit and now plans to buy another property using the same method of accessing the line.
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Douglas Skipworth, CPA, CFA is the Co-Founder and Principal Broker at CrestCore Realty in Memphis, TN. CrestCore manages over 2,500 units for approximately 500 individual investor
clients, of which Douglas and his business partner Dan Butler are the largest. Connect with Douglas at douglas@crestcore.com.
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