Should You Get an Equity Loan on Your Investment Property? A Complete Guide

As a real estate investor, you likely know that tapping into your property’s equity can be a smart financing strategy. But is taking out an equity loan on your rental property the right move?

In this comprehensive guide, we’ll cover everything you need to know about equity loans on investment properties.

What Are Equity Loans?

Equity loans allow homeowners to leverage the equity they’ve built up in their home for large cash sums that can be used to finance home renovations, investments, debt consolidation, and more.

With an equity loan, the amount you can borrow depends on how much equity you have, also known as your loan-to-value ratio (LTV). Equity loans typically allow you to borrow up to 85% of your home’s value minus what you still owe on your mortgage.

Equity loans provide lump sum payouts and come with fixed interest rates and set repayment terms over a certain number of years. This differs from home equity lines of credit (HELOCs), which offer revolving credit lines with variable rates.

Why Investors Use Equity Loans

Investors choose to tap into their rental property’s equity for a few key reasons

• Finance property repairs or renovations: Costly improvements like kitchen remodels, roof replacements, and HVAC upgrades can be funded through equity loans rather than out-of-pocket. This frees up cash.

• Consolidate higher interest debt Equity loans usually have lower rates than credit cards or personal loans so they can save investors money.

• Purchase additional investment properties: Real estate investors may use equity loan proceeds as down payments on new properties to expand their portfolios.

• Cover emergency costs: Unexpected property repairs or periods of vacancies can put investors in a financial bind. Equity loans provide fast access to funds.

• Diversify their investments: Some investors leverage equity to purchase stocks, bonds, or invest in businesses, allowing them to diversify.

Pros of Equity Loans on Investment Properties

Let’s explore some of the biggest advantages equity loans offer real estate investors:

• Typically more affordable than alternatives: Equity loans tend to offer lower interest rates compared to other financing options like personal loans or credit cards. Their rates are also fixed, avoiding unpredictable rate hikes.

• Access to larger loan amounts: Investors can tap into their biggest asset (their property) to receive lump sums well over $100K in many cases. Other loan types cap out at much lower amounts.

• Pay only interest initially: Most equity loans offer interest-only payments for the first 5-10 years of the loan. This keeps payments low when funds are first received.

• Potential tax deductions: Interest paid on equity loans used to finance property repairs or improvements may be tax deductible, providing savings.

• Build business credit: Making regular equity loan payments can help investors strengthen their business credit profile over time.

• Keep rental income flowing: Tapping equity leaves rental income intact, versus a cash-out refinance which must be repaid from rents received.

Cons of Equity Loans on Investment Properties

Equity loans also come with some downsides for investors to be aware of:

• Risk putting property ownership at stake: Defaulting on an equity loan could result in foreclosure, causing investors to lose assets and rental income streams.

• Require excellent credit: Most lenders only approve borrowers with credit scores over 720 for equity loans. Their standards are strict.

• Come with closing costs: Origination, processing, appraisal and other fees can reach into the thousands, reducing loan proceeds.

• Disrupt long-term strategies: Equity loans deplete equity investors spent years building, which could limit options later and inhibit long-term growth.

• Can be expensive long-term: While starting payments are often interest-only, eventually principal must also be repaid. This increases long-run costs.

• Reduce future borrowing power: As loan-to-value ratios rise, investors’ ability to qualify for additional financing decreases.

Equity Loan Requirements

Qualifying for an equity loan on a rental property involves meeting rigorous criteria. Here are typical requirements:

• 720+ credit score – Most lenders want to see excellent credit. Anything under 700 will be a very hard sell.

• 50% or lower DTI – Your total debts divided by income should not exceed 50% in most cases. The lower, the better.

• 70-80% LTV or lower – You’ll need 20-30% equity in the property before tapping more through a loan.

• 2+ years of rental history – Seasoned investment properties are less risky to lenders than new ventures.

• 25%+ equity remaining – After the loan, investors still need enough equity left over to weather housing market fluctuations.

• 3-6 months reserves – Lenders want to see ample cash buffers in your bank account to handle unexpected costs.

• Sufficient rental income – Enough monthly rental income to comfortably cover the new loan payment is required.

As you can see, the bar is high. Working with an experienced mortgage broker is key to successfully navigating the process.

How Much Can Be Borrowed?

The amount you can borrow through an equity loan depends on factors like:

• How much existing equity you have – More equity equals a higher loan amount. Typical LTVs range from 70% to 85%.

• Your property value – Higher value homes leave room for larger loans. Lower value homes limit potential proceeds.

• Your income and debts – Your DTI plays a role in loan sizing, with lower DTIs allowing larger loans.

• Loan term chosen – Loan terms of 10, 15, 20 or 30 years result in different maximum approvable amounts.

• Lender’s specific policies – Each lender has its own formula for loan sizing, and may be more conservative.

While there are no hard and fast rules on Exact loan amounts, many investors find they can borrow between $50,000 to $200,000 through an equity loan on a rental property.

How Much Does It Cost?

The exact cost to take out an equity loan on your investment property will vary, but fees normally include:

• Interest rate – Rates currently range from 7% to 15% for equity loans. Your specific rate depends on your financial profile.

• Origination fee – Upfront fee of 1% to 6% of the loan amount to initiate the application.

• Third-party fees – Appraisal, credit check, title fees, and more that usually add up to around $2,000.

• Prepayment penalties – Some lenders charge fees if loans are paid off early, usually around 5% of the balance.

• Closing costs – Additional title insurance, recording, and other closing fees range from $1,000 to $2,500.

In total, equity loan costs end up being around $5,000 to $10,000 on average based on the size of the loan.

Alternatives to Equity Loans

Other options beyond equity loans are worth considering as well, such as:

• Cash-out refinancing – Also taps equity but folds it into a new first mortgage. Typically has lower rates than equity loans.

• HELOCs – Revolving credit line offers flexibility to access funds as needed. Interest is also usually tax deductible.

• Hard money loans – Asset-based loans from private lenders offer quick funding but at high rates.

• Business lines of credit – Unsecured credit lines don’t put properties at risk. Downside is lower approvable amounts.

• Private money lenders – Individual investors provide financing at higher rates in exchange for collateral.

• Crowdfunding – Pooling funds from a crowd of backers is growing in popularity. Provides access to more money.

Each option carries its own pros, cons and qualification hurdles. Consulting a financial advisor can help determine the best route.

Where to Get an Equity Loan

Many traditional banks and credit unions offer equity loans. Online lenders are also increasingly providing them, which expands investors’ options.

Mortgage brokers are very helpful for shopping multiple lenders at once. They have insight into niche equity loan programs that meet investors’ specific needs.

Key is focusing on reputable lenders that offer competitive rates and reasonable fees. Never rely solely on advertised rates since actual offered terms depend on individual factors.

Using Equity Loan Funds Responsibly

Before moving forward with an equity loan against your rental property, ask yourself:

• Do I absolutely need to tap this equity now? – Or can I wait and build more value over time? Don’t rush into equity withdrawal.

• Does this purchase or investment really make sense? – Ensure you have a solid, justified purpose for the funds that aligns with your goals.

• Can I repay the loan comfortably? – Never borrow more than existing rents can cover. Leave room for vacancy periods and maintenance costs too.

• **Am I sacrificing