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Lured by a lower cost of living and more affordable real estate, places like Mexico, Costa Rica and the Philippines top the list of countries where Americans move after retirement or buy investment property, according to a survey by Wire Consulting, an international real estate consulting firm.
If you’re interested in buying a property overseas, a home equity line of credit (HELOC) can be a good option to help finance your expenses. But before you go this route, it’s a good idea to consider the pros and cons as well as alternative options.
Tapping your house for cash
After the housing crash, Alicia Cramer bought properties in San Diego and Las Vegas, which she now uses to buy real estate abroad. Instead of divesting her property, she’s using the equity, in the form of a home equity line of credit, or HELOC, to fund her new investments.
“The HELOC was the best way to go if I didn’t want to sell everything. Selling everything takes time anyway; a HELOC was faster,” says Cramer, a Las Vegas-based real estate investor. “And I don’t necessarily want to sell those properties, so this was a good solution.”
However, before you refinance your house to buy another house overseas, it’s important to consider the risks, says Danilo Kawasaki, co-founder/COO Gerber Kawasaki, a wealth and investment management firm based in Santa Monica, California.
“If the goal is to be cash-flow positive, then getting a HELOC might not be the best choice,” Kawasaki says.
Because each situation is unique, talk with your financial advisor before you take out a loan that could potentially put your existing house in jeopardy if you’re unable to make payments, Kawasaki says. You can also look at current HELOC rates to help you make an informed decision.
Financing foreign real estate
Local mortgages can be difficult to secure as a way to finance purchasing a property abroad. Even if mortgages exist in the area, you’ll likely find the terms to be far less desirable than the ones in the U.S. While each country is different, you can expect to pay a higher interest rate plus a down payment of 30% or even more of the property’s value.
In addition, you may be forced to invest in a life insurance policy for the mortgage amount and name the bank as a beneficiary. For these reasons, it’s wise to finance a property overseas with a HELOC or methods other than a local mortgage.
Pros of getting a HELOC to buy foreign property
Quick and easy
A HELOC offers two things: capital and convenience. Borrowers can get a HELOC in as little as two weeks, depending on your lender and how quickly you can submit your paperwork. HELOCs require credit approval, proof of income and loan-to-value ratio, or LTV. Typically, borrowers need a credit score of 620 or higher.
“The advantage is that the HELOC provides access to capital for the person who has a home in which he or she has significant home equity. And then they get this HELOC money to potentially invest in real estate,” says Shreesh Deshpande, finance and real estate chair at the University of San Diego.
More cash, better terms
With HELOCs, your credit line is determined based on the equity in your home. Banks normally lend between 75 and 80 percent of the home’s value. So, if you own your home outright and it’s appraised at $300,000, the bank might lend you 75 percent of the value, which is $225,000.
Most lenders have a maximum unsecured personal loan amount of between $40,000 and $50,000. However, there are lenders who will lend more. For example, SoFI offers $100,000 loans to people who have a minimum 680 credit score. However, the interest rate on that loan ranges from 7 to 15 percent, which is higher than most HELOCs. At Bank of America, borrowers with excellent credit scores can get HELOC rates starting at 3.48 percent.
Personal loans often have shorter terms, which can be challenging for some borrowers. Typically, borrowers must repay the loan in one to seven years. HELOC borrowers have more time to repay. They can choose among various term limits, from 10 to 25-years. The loan is split into two periods: the draw period and the repayment period.
You do not have to sell first
If you don’t want to sell your house to buy another house, a HELOC might be a good option.
There are many reasons why homeowners would want to hang on to their home, says Deshpande. In this instance, a HELOC could be a good alternative to selling.
“A lot of times the scenario is that somebody is planning to retire six years from now, but they still need to live in their existing property for six years, so they keep their house while buying a house in a foreign country,” says Deshpande.
“The other thing is that people want to have one foot in the U.S. and one foot abroad. A lot of the rationale has to do with staying close to their family. They have children and grandchildren in the U.S. so they don’t want to completely move.”
Advantages over cashing in stocks and bonds
Homebuyers can also cash in stocks and bonds. However, there may be tax implications, and this will limit your access to cash down the road.
Assess how much your investments are currently returning compared with the interest on a HELOC. You’ll also want to find out what the costs associated with cashing in your stocks and bonds are, says Bill Rayman, vice president of mortgage lending at Guaranteed Rate.
“If you have a Vanguard fund earning 9 percent and the HELOC interest rate is 4 or 5 percent, I’d rather get the HELOC and continue earning 9 percent with my Vanguard account,” Rayman says. “Plus, there could be transaction costs, there could be capital gains. It would erode all the money they’d be making on those investment accounts.”
It’s also important to be diversified, says Rayman. By using your stocks and bonds to buy more real estate, you’ll be highly concentrated in one asset class.
Cons of getting a HELOC to buy foreign property
Risk of foreclosure
HELOCs can be dicey because your home is the collateral. If you’re unable to make payments, the bank can take possession of the property.
“The bottom line is that if someone takes out a HELOC to buy an investment property abroad or wherever else, the person has increased their leverage or the amount of debt they have. So it’s definitely not reducing risk, it’s increasing risk,” says Deshpande.
Rates are adjustable
Traditionally, HELOCs are variable-rate loans. However, there are hybrid options that allow borrowers to pay a fixed rate on a portion of the credit line and an adjustable-rate on the remainder. Ask your lender what they offer and what their HELOC rules are.
Chase, for example, has a fixed-rate HELOC option which allows borrowers to switch from adjustable rates to a fixed rate during the draw period on loans of more than $1,000.
“The downside of a HELOC is that the rate can change over time. After 10 years the loan will be fully amortized and people get stuck with them. It’s a riskier loan, but usually easy to get,” says Rayman.
You can’t deduct the interest paid
One advantage of HELOCs used to be the tax breaks for homeowners. That’s not the case anymore. The Tax Cuts and Jobs Act of 2017 eliminated the ability to deduct the interest borrowers paid on HELOCs, unless they used the funds to buy, build or substantially improve their home.
“The new tax laws eliminated a big incentive to get a HELOC: the deduction,” says Kawasaki. “This makes HELOCs a lot less attractive than they used to be.”
Experts agree that paying for your home abroad is just one part of the equation, buyers should also get sound advice from people who know the country, region and even neighborhood.
“I have property in Brazil that I inherited from my mother and it definitely helps that I know the country. I would recommend that anyone who wants to invest in foreign real estate should do their homework. Go out there, book some Airbnbs, talk to experts in the area,” Kawasaki says.
Americans who live abroad should also enroll in the Smart Traveler Enrollment Program, or STEP, says a spokesperson for the State Department.
“STEP is a good way for Americans to find out what’s going on in the country they’re living in, about any safety concerns and other information,” the spokesperson says.
Other options for financing property overseas
Cash can be ideal if you’d like to buy a property overseas. You can leverage it to negotiate the best possible price. You may also expedite the closing process significantly. Note that paying cash, however, makes the most sense if the property you’d like is already built.
If you pay cash for a property that will be built in the future, the developer may run out of funds or come across another issue that delays your project or prevents it from being completed. In this scenario, it can be time-consuming and challenging to get your cash back.
Employing developer financing
If you wish to buy a lot, home site or pre-construction property in the development phase, developer financing may be an option. Fortunately, it usually comes with minimal paperwork and doesn’t require you to purchase life insurance. Depending on the country and developer, you may also lock in zero interest.
Every type of developer financing is different, so read the fine print before you sign on the dotted line. Also, be sure you can repay the money you borrow with the repayment terms outlined in your contract.
Using a self-directed IRA
A self-directed IRA can be a great resource if you plan to use a house abroad as a rental or investment property. While traditional IRAs limit investments to stocks, bonds and mutual funds, a self-directed IRA can allow you to invest in real estate in the U.S. or overseas. Because you’ll need to treat the property as a real estate investment, you won’t be able to live in it until you reach the age where you can start to receive distributions.
The bottom line
While all real estate transactions are complex, those that involve a property overseas come with an extra set of challenges. If you’re in the market for a house abroad, explore all your payment and financing options. Then, reach out to a real estate attorney or experienced real estate professional who can help you with the paperwork and guide you through the process. By doing so, you can protect your rights and avoid unnecessary roadblocks.