Should You Get a HELOC Loan for Your Investment Property? A Complete Guide

Investment properties can be great opportunities to build long-term wealth. But purchasing and maintaining an investment property also requires significant upfront and ongoing costs. If you’re looking for a way to tap into your existing property equity to finance investment property expenses, a home equity line of credit (HELOC) may seem appealing.

I’ll explain what a HELOC is, how it works for investment properties the pros and cons of using a HELOC loan for real estate investing and alternatives worth considering. By the end of this guide, you’ll understand if a HELOC is the right financing option for your rental property portfolio.

What is a HELOC and How Does it Work?

A home equity line of credit (HELOC) is a revolving line of credit that allows you to borrow against the equity in your home.

Here’s a quick rundown of how HELOCs work:

• You apply for a HELOC up to a set maximum limit based on your home’s appraised value and how much equity you have.

• Once approved, you enter a draw period (usually 10 years) where you can access the funds as needed. You only pay interest on what you actually use

• After the draw period ends, you enter the repayment period where you must pay back the principal within a set timeframe, usually 20 years.

• HELOCs have variable interest rates, so your monthly payments fluctuate based on rate changes.

• Secured by your home, a HELOC’s use of funds is flexible. You can use it to finance home improvements, debt consolidation, emergencies, investments, and more.

Key Differences for Investment Property HELOCs

While HELOCs for primary residences are common, here are some key considerations for using a HELOC on a rental property:

• Higher costs: HELOC rates and fees are usually 0.5% – 1% higher for investment properties.

• Lower limits: Maximum HELOC limits are typically lower, usually up to 70% – 80% loan-to-value ratio.

• Stricter criteria: Minimum credit scores around 720+ and debt-to-income ratios below 50% are common requirements. Steady rental income is a must.

• Fewer lenders: Not all lenders offer HELOCs for non-owner-occupied properties.

• Tax benefits: Interest may be tax deductible if used for property expenses or improvements.

Pros of Using a HELOC for Investment Property

Utilizing a HELOC for your rental property has some potential benefits:

• Access extra funds: A HELOC provides a revolving source of financing you can tap anytime.

• Pay only for what you use: You only incur interest fees on the amount withdrawn.

• Flexible usage: Use the line of credit for any purpose, from renovations to new property purchases.

• Potential tax deductions: Interest expenses may qualify as tax deductions.

• Keep your equity liquid: Maintain easy access to property equity without needing to sell.

Cons of Using a HELOC for Investment Property

There are also some downsides to weigh:

• Higher costs: Expect to pay more in fees, interest rates, and closing costs compared to primary residence HELOCs.

• Rising payments: Since HELOCs have variable rates, your monthly payments can increase over time as rates increase.

• Risk losing property: If you default, the lender can foreclose on the property used as collateral.

• Short draw period: The draw period is usually under 10 years.

• Ongoing debt obligation: You take on 20+ years of debt payments reduced only by your monthly principal payments.

• Prepayment penalties: Some lenders charge fees for paying off a HELOC early.

HELOC Alternatives for Investment Properties

Before getting a HELOC, also consider these other financing options:

• Cash-out refinance: Refinance your investment property into a larger loan to tap equity, often at a lower fixed rate. You can use the funds however you want.

• Primary mortgage HELOC: Qualification is easier for a HELOC on your owner-occupied home. Use the funds for rental property expenses.

• Home equity loan: This term loan provides a lump sum upfront. You get predictable fixed monthly payments over a set repayment term.

• Hard money loans: These short-term loans are easy to qualify for and fund quickly, but have high rates. Best for fix-and-flips.

• Unsecured personal loans: These loans don’t use property as collateral. Shop for the best rates and use the lump-sum as you want.

• Business lines of credit: Some banks offer lines of credit for LLCs and other business entities that own investment properties.

Tips for Getting a HELOC for Your Rental Property

If you decide a HELOC is the right financing move for your real estate investments, here are some tips:

• Have a credit score over 720, low debt-to-income ratio, and substantial rental income from long-term tenants.

• Shop with small banks, credit unions, and mortgage brokers. Avoid big banks that are less likely to approve investment property HELOCs.

• Seek 80% or lower loan-to-value ratios. This provides a buffer so the lender can sell the property if you default.

• Be prepared to pay 1% – 2% higher rates and fees versus primary residence HELOCs.

• Use a HELOC draw period to establish a line of credit for future rental property opportunities, rather than withdrawing the maximum amount upfront.

Can You Use a HELOC For an Investment Property Down Payment?

Yes, you can use HELOC funds toward a down payment on another investment property. Since a HELOC is unrestricted, the lender does not monitor or control how you use the funds.

However, keep a few things in mind:

• Your debt-to-income ratio will increase, making it potentially harder to qualify for a competitive rate on a new investment property purchase.

• Dipping into your current property equity reduces a key contingency fund for emergency repairs or periods of vacancy.

• If local housing prices decline, you may end up owing more than your properties are worth.

Frequently Asked Questions

Can I get a HELOC on a rental property I don’t live in?

Yes, it is possible to get a HELOC loan for an investment property you rent out but do not occupy. Just be aware requirements are stricter and fewer lenders offer them compared to primary residence HELOCs.

What can I use a rental property HELOC for?

A HELOC provides an unrestricted line of credit, so the funds can be used for any legal purpose – investment property renovations, purchasing another rental, or even personal expenses unrelated to the property.

Are HELOC interest payments tax deductible for rental properties?

In most cases, yes. The interest expense on a HELOC used for financing the rental property may be tax deductible. Consult a tax professional to understand how tax deductions may apply to your specific situation.

Should I get a HELOC or cash-out refinance for my investment property?

A cash-out refinance converts existing equity into a new fixed-rate mortgage. This allows you to tap equity and provides long-term payment stability. A HELOC gives you an open line of credit but payments and rates fluctuate. Choose the option that best aligns with your financial needs and goals.

What are the risks of getting an investment property HELOC?

The lender can foreclose on the property if you miss too many payments. With variable rates, monthly payments can increase to unaffordable levels. Also, accessing too much equity reduces a key contingency fund for when tenants fail to pay rent or unexpected repairs arise.

The Bottom Line

A HELOC can provide a flexible financing option to leverage your rental property equity. But higher costs, stricter approval criteria, and risks associated with variable rates and ongoing debt make a HELOC less than ideal for some real estate investors.

Carefully compare all your options – from cash-out refinancing to alternative loans or lines of credit. Determine what best supports your investment strategy and financial situation. With thorough planning and research, you can make informed financing decisions to build your rental property portfolio.