Using Home Equity to Finance an Investment Property: A Complete Guide

Investing in real estate can be an excellent way to build long-term wealth. However, coming up with the down payment for an investment property can be a major hurdle especially for first-time investors. If you’re a homeowner tapping into your home equity can give you the funds you need to purchase your first rental property or vacation home.

In this comprehensive guide, we’ll explain everything you need to know about using home equity to finance an investment property, including:

• What is home equity and how much do you have?
• Home equity loan options for investors
• Key factors to consider
• Strategies for using home equity to buy investment property
• Alternatives if you don’t have enough equity

What is Home Equity and How Much Do You Have?

Home equity is the difference between what your home is worth and what you still owe on your mortgage. For example, if your home is worth $300,000 and you owe $150,000 on your mortgage, your home equity is $150,000.

You can use home equity calculators online to estimate how much equity you have in your home. Just input your home’s estimated value and remaining mortgage balance to find out

Keep in mind you likely won’t be able to borrow 100% of your equity. Most lenders limit home equity loans to 80-85% loan-to-value. So in the example above you may be able to borrow around $120,000 to $127500 against your home equity.

Home Equity Loan Options for Real Estate Investors

If you decide to use home equity to finance an investment property, you have three main options:

Cash-Out Refinance

With a cash-out refinance, you replace your existing mortgage with a new, larger loan. After paying off your current mortgage, the extra funds are paid out to you in cash to use as you wish.

Pros: Lower interest rates than other home equity loans.

Cons: Closing costs and increased mortgage payments. You also lose any benefits of your old mortgage.

Home Equity Loan

A home equity loan provides you with a lump sum of cash upfront. You repay the loan with fixed payments over a set term, usually 5-30 years.

Pros: Fixed rates and consistent payments. Can get funds in a lump sum.

Cons: You pay interest on full amount even if you don’t use all the funds. Rates higher than refinancing.

HELOC

With a home equity line of credit (HELOC), you have access to a revolving credit line based on your home equity. You can draw against the line as needed.

Pros: Only pay interest on what you use. Can re-use funds. Lower rates than home equity loans.

Cons: Variable rates. Payments spike when draw period ends.

Key Factors to Consider

Before using home equity to buy an investment property, be sure to consider:

• Your financial situation – Make sure you can afford the increased monthly payments. Don’t overextend yourself financially.

• Your equity – Calculate precisely how much equity you have available to tap and how much you’ll need for the down payment and closing costs.

• Loan costs – Compare total loan costs across different home equity products. Closing costs differ.

• Risks – Using home equity adds risk. If you default, you could lose your home. Manage the risks wisely.

• Rates and terms – Compare rates and terms to find the most affordable option for your situation. Ask about prepayment penalties too.

• Taxes – Consult a tax pro to understand any tax implications of tapping home equity.

Strategies for Using Home Equity to Buy Investment Property

If you’ve decided to tap your home equity to invest in real estate, here are some smart strategies to consider:

• Use equity for the down payment – This is the most common approach. Draw just enough to cover the down payment and closing costs.

• “House hacking” – Some special mortgage programs allow you to buy a multi-unit property, live in one unit, and rent the others.

• Buy a foreclosure/distressed property – Use equity to purchase and renovate a foreclosed or rundown home at a discount. Fix it up and resell for a profit.

• Finance repairs on a “fixer-upper” – Borrow against your equity to fund repairs on a home you plan to fix and flip. Can get better rates than a private renovation loan.

• Purchase real estate investment trusts (REITs) – Invest equity in a REIT to get exposure to rental real estate without the headaches of being a landlord.

• Fund a down payment on a vacation rental – Use equity to buy a second home or vacation property that you’ll rent out part-time on sites like Airbnb or VRBO.

What If You Don’t Have Enough Home Equity?

If you lack sufficient home equity to fully finance an investment property, here are some potential alternatives to consider:

• Personal loan – An unsecured personal loan can provide funds for a down payment without putting your home at risk.

• Hard money loan – Hard money loans are asset-based loans from private lenders. Higher rates but easier to qualify.

• Commercial loan – Some banks offer commercial real estate loans for investors, even those just starting out.

• Partnerships – Join forces with other investors to pool funds for a larger down payment.

• Non-bank lenders – Online lenders may offer investment property loans with lower FICO requirements.

• Government programs – FHA, VA, and USDA loans allow small down payments on investment properties in some cases.

The bottom line is that tapping home equity can be a smart way for real estate investors to unlock funds for that crucial down payment. Just be sure to research all your options, run the numbers carefully, and consult professionals to fully understand the risks and tax implications involved. Use home equity strategically as part of your overall investment plan.