Should You Get a HELOC Loan For Your Investment Property? A Guide for Real Estate Investors

Investment properties can be a great way to generate passive income and build long-term wealth through real estate. As your investment property appreciates in value over time, you may want to tap into the equity to finance renovations, repairs, or even use it to purchase another investment property This is where a home equity line of credit (HELOC) can come in handy for real estate investors

What is a HELOC Loan and How Does it Work?

A HELOC loan is a revolving line of credit that allows you to borrow against the equity in your home It works similarly to a credit card in that you have a set credit limit, can withdraw money as needed, and only pay interest on the amount borrowed

Here’s a quick rundown of how HELOCs work

• You apply for a HELOC loan from a lender and get approved for a set credit limit based on your home’s appraised value and equity.

• During the “draw period”, usually 10 years, you can withdraw as much as you want up to your credit limit. You only pay interest on the amount borrowed.

• Once the draw period ends, the loan enters the repayment period where you must pay back the principal plus interest. The repayment period is usually 20 years.

• HELOCs tend to have variable interest rates tied to the prime rate, so your monthly payments may fluctuate.

• You can draw, pay back, and re-borrow money as long as you don’t exceed your credit limit.

Can You Get a HELOC on an Investment Property?

Yes, it is possible to get a HELOC loan for an investment property! However, it may be more difficult compared to getting one for your primary residence.

Lenders tend to have stricter eligibility requirements for investment property HELOC loans because they carry more risk. You’ll likely need:

• A higher credit score of at least 720+
• Lower debt-to-income ratio of 36% or less
• Significant equity built up in the property, usually 20% or more
• Cash reserves equal to several mortgage payments

Additionally, lenders may require a full appraisal instead of automated valuation to determine your home equity. The costs involved with getting an investment property HELOC are also usually higher.

Only some banks and credit unions offer HELOC loans for investment properties. Online lenders are another option to shop around and compare offers.

Pros of Using a HELOC on an Investment Property

• Access equity without selling: Unlock the equity in your rental home without having to sell the asset. This allows you to leverage the property equity you’ve built up.

• Pay interest only on what you use: A HELOC has a revolving line of credit, so you only pay interest on the amount withdrawn, potentially saving on interest costs.

• Variable interest rate: The interest rate is variable pegged to an index like the prime rate, giving you lower rates compared to other financing options.

• Flexibility: You can withdraw incrementally as needed, then pay back and re-borrow during the draw period as your needs change.

• Interest may be tax deductible: If you use the HELOC for rental property expenses, the interest may be tax deductible. Consult a tax professional.

Cons of Using a HELOC on an Investment Property

• Higher costs: Investment property HELOC loans often come with higher fees, closing costs, and interest rates compared to primary residence HELOCs.

• Stricter eligibility: You’ll need great credit, significant equity, and cash reserves. Requirements are tougher for investment properties.

• Variable rates: The interest rate fluctuates so your monthly payments are not fixed, making it harder to budget.

• Risks of overleveraging: Withdrawing too much equity through a HELOC can leave you overleveraged on the property, increasing foreclosure risks.

• Shorter repayment term: Typical repayment periods are 15-20 years for investment property HELOCs, shorter than the 30 years for primary residence HELOCs.

What Can You Use an Investment Property HELOC For?

A HELOC loan’s flexible access to cash makes it a useful tool for real estate investors. Here are some of the most common uses for investment property HELOC loans:

• Finance repairs or renovations for the property
• Purchase another investment property
• Pay off higher interest debt
• Finance a down payment on another property
• Cover emergency or unexpected expenses
• Pay for property taxes and insurance
• Property upkeep and maintenance costs
• Finance college tuition or other big expenses

Just remember, if you don’t use the HELOC funds for approved purposes related to the investment property, the interest may not be tax deductible.

Alternatives to a HELOC for Investment Property

If you have difficulty qualifying for an investment property HELOC, here are a few alternatives worth considering:

• Cash-out refinance: Take cash out when refinancing your rental property’s mortgage. You get a lump-sum but lose the revolving credit.

• Home equity loan: Borrow a fixed lump sum all at once instead of an open line of credit.

• Personal loan: Unsecured personal loans don’t use your property as collateral but have higher rates.

• Hard money loans: Asset-based financing from private lenders at higher rates and shorter repayment periods.

• Business line of credit: Unsecured line of credit through a business lender based on business creditworthiness.

• Fix-and-flip loan: Specialized short-term loan for financing house flipping projects.

Tips for Getting Approved for an Investment Property HELOC

Getting approved for a HELOC on your investment property can be challenging. Here are some tips that can help your chances:

• Shop around with multiple lenders to compare HELOC offers. Local banks and credit unions may have more flexible requirements.

• Ask the lender if you will qualify for a HELOC based on your financial profile before formally applying.

• Pay down existing debts and maintain a low debt-to-income ratio. Below 36% DTI is ideal.

• Build up cash reserves in your bank account equal to 3-6 months of mortgage payments.

• Boost your credit score above 720 if possible and review your credit reports. Fix any errors.

• Be prepared to make a down payment of at least 20-25% when purchasing the rental property to build equity faster.

• Explore a lower LTV HELOC requiring only 10-15% equity if you don’t have 20% equity yet.

Wrap Up: Should You Get a HELOC for Your Investment Property?

Tapping into your investment property’s equity through a HELOC loan can provide a flexible line of capital for real estate investors. While financing is possible, make sure you qualify and understand the risks and costs involved before proceeding. Shop around, compare offers from lenders, and always use HELOC funds wisely. With proper planning, a HELOC can be a strategic financing tool for your rental property portfolio.