You likely have a lot of equity in your investment property. Want to upgrade a unit, purchase another investment property, or just have some cash ready for an unexpected expense? A home equity line of credit (HELOC) can be a great way to access that equity. However, many landlords ask: Is it possible to get a HELOC on an investment property?
Yes! However, it’s generally more difficult to qualify for a HELOC on a vacation home or investment property than on your primary residence. Fewer lenders offer these loans, qualification requirements are stricter, and borrowing costs are typically higher. In this post, you’ll learn how HELOCs on investment properties work, the risks involved, and the options to consider.
What Is a HELOC on Investment Property?
A HELOC is a type of credit line that uses your home equity as collateral. Your equity is the value of your property minus what you still owe on it. Rather than receiving a lump sum, you’re approved for a credit limit that you can borrow from as needed, much like a credit card, but often at a lower interest rate.
A HELOC on an investment property is secured by your rental property (single-family home, duplex, small multifamily property, etc.). Most HELOCs are divided into two phases. During the draw period (typically 10 years), you can borrow, repay, and borrow again, and many HELOCs require only interest payments during this phase. During the repayment period (often another 10 to 20 years), you can no longer withdraw funds and must make payments toward both principal and interest.
Can You Get a HELOC on a Rental Property?
Yes, but lenders generally view investment properties as riskier than owner-occupied homes. If a borrower faces financial difficulties, they may be more likely to default on their rental property mortgage than on their primary residence. For that reason, many banks and credit unions don’t offer HELOCs on non-owner-occupied properties. Those that do often have stricter qualification requirements.
And it’s why working with a lender who gets real estate investors and can break down your options makes good sense.
Also Read: How much can I Borrow with a HELOC.
Standard Qualification for an Investment Property HELOC
Each lender has their own policies, but these are the typical criteria that will be taken into consideration:
- Significant equity. Lenders typically prefer you to maintain a substantial equity position. Investment property CLTV restrictions are likely to be lower than primary residence, perhaps between about 70% and 75%, in comparison to 80% to 85%+ for a primary home.
- Good credit. You’ll likely need to have a good or excellent credit score. Many lenders will want a score in the high 600s to 700s or higher.
- Healthy debt-to-income ratio. Your DTI shows how your monthly debt payments compare to your income. Most lenders like a DTI of under about 43% to 45%, though some may be OK with a higher DTI.
- Rental Income already accounted for. Lenders may examine a lease, income tax return, and/or a background of satisfactory rent collection to substantiate the rental income.
- Cash reserves. Other lenders want to see that you have a few months of payments – including mortgage payments and others — set aside to help cover vacancies and repairs.
What Will It Cost?
Most likely, you will be offered a higher interest rate on a HELOC for your investment property than on your primary residence. Many HELOCs offer variable rates tied to a benchmark such as the prime rate, which means your payment may go up or down over time.
In addition to the rate, inquire about closing costs, appraisal costs, annual rates, and any charges for early termination or inactivity. These can be quite costly, so you’ll want to compare the actual cost of borrowing, rather than the advertised rate.
Smart Ways to Use a HELOC on a Rental Property
Properly utilized, a HELOC is a powerful asset for building a real estate portfolio. Typical applications include:
- Renovating and repairing kitchens, installing new units, or a new roof can also add to the amount of rent you receive.
- Investment property down payment. Investors commonly leverage the equity of one property to finance the acquisition of the next.
- Reserve funds. A short-term loan can provide interim funding for vacancies, emergency repairs, or cash flow deficiencies.
The trick is to borrow for a reason that will produce a return. If you use a HELOC for discretionary expenses, you’re putting your investments at risk for no return.
Risks to Consider Before You Borrow
As it is guaranteed by your property, you could lose your rental if you default on payments. Risks of a HELOC include:
- Variable rates. Payments may increase sharply if the rate increases, especially when the interest-only period ends and you are paying back the principal.
- Payment shock. Transitioning from an interest-only payment to a principal and interest payment can take a big chunk out of your monthly budget.
- Market and vacancy risk. You could end up paying more than you anticipated if the value of the property drops or if the unit remains vacant.
- Get the numbers right before you borrow. The rent has to cover all of the expenses, including the new payment, without getting tight even if interest rates increase or if there is a vacancy.
A Note on Taxes
Interest on Money Borrowed Against a Rental May Be Deductible. Whether the interest on borrowing against rental property is deductible depends on what you do with the money borrowed. Usually, what the borrowed money is used for is what matters, not the real estate that secures the loan. Consult a tax expert before assuming anything is deductible.
Alternatives to a HELOC on an Investment Property
On the other hand, if you don’t have a HELOC or it doesn’t align with your goals, you may want to explore the following:
- HELOC on your main home. If you have equity in your home, you may be able to borrow against it at more favorable rates and conditions – but your home is the collateral.
- Cash-out refinance. You replace your existing mortgage with a higher balance, and you walk away with the difference in cash. This is useful if you want a large lump sum and a fixed rate, but you lose the terms of your current loan.
- Home equity loan. A second mortgage that disburses a lump sum at a fixed rate with set payments.
- DSCR loans. DSCR loans pre-approve you based on income from the rental property, instead of your income, making this type of financing appealing to many investors.
All three options have trade-offs for cost, speed, and risk – choose to match the goal.
How to Increase Your Odds of Getting Approved?
Thinking of applying? Do your homework. Reduce your debt to improve your DTI, review your credit reports for errors, document your rental income and expenses, build your cash reserves, and compare offers, because criteria and terms can differ significantly among lenders.
Final Thoughts
Yes, you can. Investment property owners generally face stricter lending criteria, lower borrowing limits, and higher interest rates than those offered for primary residences. Still, for investors with substantial equity, stable rental income, and good credit, an investment property HELOC can be a flexible financing option to help support their property investments.
The best one for you will depend on your personal objectives and your figures. At Reliance Financial, our Financial Service team will be able to advise you on your options, the associated costs, and help you select a route that will enable you to achieve your investment plans. Call us today to discuss your circumstances and what options may be open to you.
FAQs
What is equity for a HELOC on a rental?
Lenders typically require you to hold a substantial equity position. Combined loan-to-value caps on rentals are typically in the 70% to 75% range, but can be lower or higher depending on the lender, property, and borrower type.
Are HELOC rates higher on investment properties?
Yes, for the most part. A rental property’s HELOC is a riskier investment for the bank, so your rate is probably higher than it would be on a primary-residence HELOC. It will most likely be a variable rate, too.
What credit score and debt-to-income ratio do I need?
What to expect: A lot of lenders have a minimum credit score in the high 600s to 700s or higher and a debt-to-income ratio of around 43% to 45% or less. Exact limits vary, so ask your lender.
What can I use an investment property HELOC for?
Typical reasons for borrowing are for renovations, deposits to purchase other properties, and reserves for voids and repairs. Borrow for income-producing reasons since the investment property will be the security on the loan.
What are the alternatives to a HELOC on a rental property?
You can also use a HELOC on your own home, a cash-out refinance, a home equity loan, or a DSCR loan (most often based primarily on the rental income of the property). Shop for costs first.
