Explore your mortgage options
If you own a second home that you rent out – a full-time rental property or another investment property – you may wonder how to get the most value from your real estate investment.
One way is with a home equity line of credit (HELOC). As the name suggests, you can use this type of loan to borrow against a home’s available equity (which is the difference between what you owe and the value of your property).
But is this the right option for you? Read on to find out.
What Is a Home Equity Line of Credit (HELOC)?
When you have equity in your home, why not borrow against it? You can use your home’s value to accomplish goals with a home equity line of credit (HELOC). A HELOC is similar to a home equity loan, but with a HELOC, there’s greater flexibility around how and when you access equity. It’s a bit like a credit card, but typically with lower interest rates, and your home is used as collateral to secure the loan.
Most HELOCs have two stages:
- The draw period: For the first 5 – 10 years, you can draw from your home equity, and you only need to make minimum monthly payments to cover the interest on the line of credit. As you pay down your loan balance, you can continue to draw on available equity.
- The repayment period: After the draw period, you won’t be able to borrow from your home equity anymore. You’ll then have up to 20 years to pay off the remaining balance.
HELOCs often come with variable interest rates that go up or down based on market interest rates. Depending on the terms of your HELOC, the interest rate can change every month or year.
Why Take Out a HELOC on an Investment Property?
If you have an investment property, you want to get the most value from it. Taking advantage of available equity can help you further your financial goals. If you have enough equity in your investment property, you can use it to:
- Make a down payment on another investment property
- Renovate or repair your existing property
- Pay down higher-interest debt
While HELOCs usually have a variable interest rate, which can be higher than a 30-year fixed-rate mortgage or a home equity loan, a HELOC does tend to offer lower interest rates than unsecured personal loans or credit cards.
HELOCs also offer greater flexibility because you can use the money whenever you need it. For instance, you can use some of the money to make payments to multiple vendors by check or debit card, and you can leave a line of credit for emergencies or future plans.
Pros and Cons of Taking Out a HELOC on an Investment Property
There are many reasons why you might want to take out a HELOC on your investment property. But there are costs and risks to consider before you commit.
You can draw whatever amount of money you need up to the limit of your HELOC. There’s no minimum amount necessary to borrow, and you repay only what you borrow, with interest.
You can access your credit line, repay it and borrow again as many times as necessary during the draw period.
Because your home is used as collateral to secure the loan, you’re offered a lower interest rate than most credit cards or unsecured personal loans.
You can use the money you borrow to go back to college, for medical expenses, to make a home renovation, invest or expand your financial portfolio.
HELOC lenders know that if things go wrong, homeowners will prioritize mortgage payments on their primary residence over their investment property. To offset the increased risk of loan default on the investment property, lenders charge a higher interest rate.
Because most HELOCs come with a variable interest rate, it can be difficult to predict how much you’ll need to set aside to cover monthly payments. Read the terms of your HELOC to learn what the maximum cap is on your interest terms.
Pay attention to the variable interest rate and how much you’re borrowing during the HELOC draw period. You don’t want to borrow more money than you can afford to repay once the draw period is over.
The interest rates on HELOCs are usually lower than interest rates on personal loans or credit cards because they’re secured loans. That means you’re using your investment property as collateral. So if you miss payments, a lender can foreclose on your investment property.
What are the Requirements to Qualify for a HELOC on an Investment Property?
Before a lender can approve you for a HELOC on an investment property, they must consider your:
You can usually qualify for a HELOC with a credit score of 620 or higher. Lenders typically want higher credit scores to qualify for a HELOC on an investment property.
If you can’t meet the credit score threshold, lenders will likely charge you more in interest.
To get the best interest rates on a HELOC for an investment property, you’ll want to aim for a credit score of 740 or higher. You’ll also need at least 20% in equity in the property, though this is also up to the lender.
Combined loan-to-value (CLTV) ratio
Lenders usually require that you maintain a combined loan-to-value (CLTV) of 75% – 80%. That means what you owe on your existing mortgage combined with the amount you borrow using a HELOC can’t equal more than 75% – 80% of the property’s value.
To qualify for a HELOC on an investment property, lenders want to see that you have at least 2% of your unpaid principal balance (UPB) or the remaining balance on your mortgage saved and readily available in case of emergencies or rental income shortfalls.
This often equals enough to cover 2 – 6 months of minimum mortgage payments, including the principal, interest, taxes, insurance and association dues (PITIA). Some lenders may require as much as 12 – 36 months (1 – 3 years) in cash reserves.
You can have the money in a savings account, checking account, CD, money market account or as liquid assets (like stocks or bonds) in a brokerage account. Lenders usually won’t consider money held in a retirement account, like a 401(k) or IRA.
Your lender will also want to see that your investment property is earning money. This means you’ll need to provide a breakdown of how much you’re collecting in rent each month.
Lenders like stability. Too many short-term tenants (renting for a year or less) may raise a red flag, suggesting there’s something undesirable about the property or how it’s managed.
What Tax Benefits Can I Get With a HELOC on an Investment Property?
Investment properties come with many tax benefits, including the ability to write off a portion of the mortgage interest on a HELOC. Writing off the mortgage interest lets you lower your income on your tax return, so you pay less overall.
However, the 2017 Tax Cuts and Jobs Act (TCJA) changed the rules in two key ways.
Lower mortgage interest deduction
HELOC interest deduction limitations
Another TCJA provision is that you can only deduct mortgage interest on a HELOC if you use the money to buy, build or repair the property you’re borrowing against.
With a HELOC on an investment property, you can write off the interest if you use the money to upgrade the property or buy another property. You can’t write off the interest if you use the money to pay off personal debts.
What Are the Alternatives to a HELOC on Your Investment Property?
If a HELOC on an investment property doesn’t make sense for you, there are other ways to borrow the money you need.
A cash-out refinance (or cash-out refi) is essentially a new mortgage on your investment property. The difference between a cash-out refi and a standard refi is that you can borrow more than you owe. Pro tip: Most lenders only let you cash out up to 80% of your home’s equity.
You use the new mortgage to pay off the original mortgage and pocket any leftover money. The key difference between a cash-out refi and a HELOC is that, with a cash-out refi, you immediately start paying interest on the loan and lose the “draw when you need it” flexibility of a HELOC.
HELOC on your primary residence
If you’re concerned about the higher interest rates that come with HELOCs on investment properties or you don’t have enough equity in your investment property, you could take out a HELOC on your primary residence.
This could be a more affordable option, but keep in mind that you’d be putting your home at risk of foreclosure if you can’t make your payments.
Unsecured personal loan
If you have good credit but don’t have the time to wait on a HELOC, you may be able to take out an unsecured personal loan. With these loans, you can usually borrow up to $100,000 (depending on your credit) and get the money within 1 – 7 business days.
Just be aware that interest rates on these loans will probably be higher than a HELOC, and you’ll need to start making payments right away.
Is a HELOC on an Investment Property Right For You?
If you have an investment property, a HELOC can be a great way to put equity in the property to good use. You can use it to upgrade your existing property or expand your real estate empire.
Like any loan, a HELOC on an investment property comes with risks. Make sure you talk to your lender and financial advisor before you make any decisions.
The Short Version
- A home equity line of credit (HELOC) is similar to a home equity loan, but with a HELOC, there’s greater flexibility around how and when you access equity
- Because most HELOCs come with a variable interest rate, it can be difficult to predict how much you’ll need to set aside to cover monthly payments
- To get the best interest rates on a HELOC for an investment property, you’ll want to aim for a credit score of 740 or higher
Fannie Mae. “B3-4.1-01, Minimum Reserve Requirements (10/07/2020).” Retrieved July 2022 from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-4-Asset-Assessment/Section-B3-4-1-General-Asset-Requirements/1032996771/B3-4-1-01-Minimum-Reserve-Requirements-10-07-2020.htm
Fannie Mae. “Loan-Level Price Adjustment (LLPA) Matrix.” Retrieved July 2022 from https://singlefamily.fanniemae.com/media/9391/display
Internal Revenue Service. “Tax Cuts and Jobs Act: A comparison for businesses.” Retrieved July 2022 from https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-a-comparison-for-businesses
Internal Revenue Service. “Interest on Home Equity Loans Often Still Deductible Under New Law.” Retrieved July 2022 from https://www.irs.gov/newsroom/interest-on-home-equity-loans-often-still-deductible-under-new-law
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