Taking out a home equity line of credit or a HELOC on your investment property is one financing option you can use to pay for renovations of a property or purchase another. But, qualifying for one is usually the biggest obstacle you'll face. So, to determine if a HELOC on an investment property makes sense for your financial situation, here's what you should know.
A financial advisor could help you put a financial plan together for your real estate investment needs.
What Is a HELOC?
A home equity line of credit, also known as a HELOC, lets you borrow funds from the equity in your home. Essentially, you put your home up for collateral and then use the line of credit the way you would with a credit card. It's a revolving line of credit that you can use and pay off continually. You can use the money from the HELOC for expenses such as a new kitchen renovation.
To take a HELOC, you must have some equity in your home. Meaning your outstanding mortgage balance is less than the value of the property. In addition, to qualify for a HELOC on your home, you usually have to meet several requirements, including:
A credit score above 620
A maximum loan-to-value ratio of 90%
Debt-to-income ratio (DTI) equal to or less than 40%
Minimum of at least 15% to 20% equity in your home
Home appraisal to estimate the value of your home
Can You Take Out a HELOC on an Investment Property?
A HELOC on an investment property works the same way. However, there are more rigorous requirements you must meet to qualify. Lenders consider default risk to be higher on investment properties, so getting a HELOC on one can be a little more complicated.
Six common hurdles you must jump over include:
A credit score above 720
A maximum loan-to-value ratio of 80%
Savings of at least six months or more of operational expenses for rental
Verification of long-term renters
Debt-to-income ratio (DTI) between 40% and 50%
Minimum of at least 20% equity in your investment property
Additionally, the lender may require multiple appraisals to validate the property's value.
How to Identify a HELOC Lender
If you think a HELOC is the right financing solution to meet your needs, it's time to explore your lending options. Here are three options to consider:
Lenders and mortgage brokers: If you're looking for a HELOC investment property lender, start by contacting your current lender or mortgage broker. You'll also want to contact at least three different lenders to determine the best options available. When reviewing your option, make sure to compare the lenders' fees, terms, and interest rates.
Real estate investing forums: You can search online for real estate investing groups through websites like Reddit or even social media. Ask members of those groups for recommendations on HELOC lenders.
Local credit unions or small banks: Some credit unions and smaller banks still offer investment property HELOCs. Search online, and you should find ones that still provide this option.
Keep in mind, though, due to the housing crisis in 2008, some financing qualifications may make it more difficult to obtain a HELOC on an investment property. So, it's wise to shop around to see which lender is more likely to approve your HELOC application.
Other Financing Options
Getting a HELOC for your investment property is possible if you meet the stringent criteria and have plenty of equity in your investment property. However, if you cannot use your investment property to finance your new financial endeavor, here are four other options to consider:
Home HELOC. A HELOC on your primary residence is one possible option. You may be able to use the equity in your home for this alternative. With the variable rates that these lines of credit normally have, from five up to ten years to take out whatever funds you may need. Then the repayment period is up to 20 years.
Home equity loan. Another option, if you have enough equity in your investment property, is taking out a home equity loan. This gives you a lump sum of money in a loan. Normally, it has monthly payments spread out over a number of years with a fixed interest rate.
Just how HELOCs on investment properties aren't frequently available, taking a home equity loan on rental properties isn't frequently available, plus they may have a higher interest rate than a primary home loan.
Cash-out refinance. With a cash-out refinance, you replace your old investment property mortgage with a new mortgage of a greater value. Then you take the cash difference to meet your financing needs.
It's important to point out that you may only be able to use 80% to 90% of your property's equity with a cash-out refinance. A cash-out refinance typically carries lower rates than a home equity loan or HELOC. The same rules apply to a HELOC; your investment property or rental property is used as collateral. This means that it puts your property in danger of foreclosure if you fail to make the payments.
Unsecured personal loan. If you don't want to use your property as collateral, an unsecured personal loan is an option worth entertaining. The eligibility of an unsecured personal loan is based solely on your credit score and finances.
When taking an unsecured personal loan, there is no down payment required, and in certain instances, your money is available the same day. However, an important point to consider is you may receive a higher interest rate than you would have if you had a secured loan like HELOC or mortgage.
Should I Use a HELOC on an Investment Property?
So, when considering if taking out a HELOC on an investment property is right for you, it's wise to weigh out the pros and cons.
For starters, HELOCs won't cost anything unless you access the funds. Therefore, you can keep the money set aside so you can access it if an expense comes up. Also, HELOCs may last for up to 10 years. This means you don't have to decide immediately how to spend or use the funds available. And you won't begin repaying the loan until you use the funds. So, you have that 10-year draw period to decide.
But, it's important to note that there are some drawbacks to using a HELOC on an investment property. These drawbacks include:
When taking out a HELOC, the arguably most significant risk is putting your investment property at risk of foreclosure. For example, if you get into a financially sticky situation and no longer repay your home mortgage or HELOC, you could lose your business and cash flow.
You will usually have a variable interest rate on your investment property HELOC. If you're not careful, a variable interest rate can become extremely expensive very rapidly, making it challenging to repay your loan.
Taking out a HELOC on an investment property can help you leverage your equity to pay for renovations, consolidate debt, or maybe even buy a new investment property. But, using this type of financing is challenging to qualify for and can put your property at risk of foreclosure. So, it's crucial to take a hard look at your finances and make sure it makes sense for your situation.
Before you make a final decision, make sure to research and compare all of your options.
Tips for Investing
A financial advisor can help you understand the advantages and disadvantages of investment properties. Finding a qualified financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
Investing in real estate can diversify your portfolio. But expanding your horizons may add additional costs. If you're an investor looking to minimize expenses, consider checking out online brokerages. They often offer low investment fees, helping you maximize your profit.
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