Leveraging Home Equity for Investment Property Loans: A Complete Guide

Investing in rental properties can be an excellent way to generate passive income and build long-term wealth However, coming up with the down payment for an investment property purchase can be challenging, especially if you don’t have much cash on hand This is where a home equity investment loan can come in handy.

In this comprehensive guide, I’ll explain what home equity investment loans are, how they work, their pros and cons, and how to determine if using home equity for an investment property loan is the right financial move for you.

What Are Home Equity Investment Loans?

A home equity investment loan allows you to tap into the equity you’ve built up in your primary residence to come up with the funds needed to purchase or improve a rental property investment

With a home equity loan, you’re essentially using your home as collateral to secure financing. The lender places a second lien or mortgage on your home, and you receive a lump sum of cash that can be used for any purpose – including real estate investing.

Home equity loans tend to have lower interest rates compared to other financing options since they are secured by your property. This can make them one of the most affordable ways to access capital for rental property investments if you have sufficient home equity built up.

How Do Home Equity Investment Loans Work?

Getting approved for a home equity loan involves a process similar to getting a primary mortgage. Here are the key steps:

• Home appraisal – The lender will order an appraisal on your primary residence to determine its market value and how much equity you have available to tap.

• Credit check – Your credit score and history will be reviewed to assess your creditworthiness. Minimum scores around 620 are usually required.

• Income verification – Proof of your income and employment will be required to ensure you can manage the additional loan payments.

• Debt-to-income assessment – Your total monthly debts compared to gross monthly income can’t exceed around 50% with most lenders.

Once approved, you’ll receive a lump sum payment upfront, which can be used for your rental property purchase and/or renovations. The loan is repaid in fixed monthly installments over a set repayment term, usually 10-20 years. Interest rates are generally fixed as well.

Pros of Using Home Equity for Rental Property Loans

Leveraging home equity for investment property financing has some nice perks:

• Lower rates – Home equity loan rates are often 2-3% lower than alternatives like personal loans or credit cards. This can equal big interest savings.

• Predictable payments – Since rates and payments are fixed, it’s easy to budget for the monthly obligation.

• Fast access to cash – You can receive funds in a lump sum quickly after approval compared to slower options like selling stocks.

• Tap equity without selling – You can access your home equity without having to sell the property or undergo a cash-out refinance.

• Potential tax benefits – Interest may be tax deductible if used for property expenses (consult a tax pro).

Cons of Using Home Equity for Rental Property Loans

However, there are also some potential drawbacks to weigh:

• Closing costs – You’ll pay origination fees, appraisal costs, and other closing expenses. These can add up to thousands.

• Risk of foreclosure – If you default, you could lose your primary home that secures the loan.

• Second monthly payment – In addition to your existing mortgage, you’ll have another monthly loan obligation.

• Prepayment penalties – Some lenders charge fees if you pay off the loan early.

• Credit score impact – A new inquiry and increase in debt could cause a short-term dip in your scores.

Tips for Using Home Equity for Investment Loans

If you determine that leveraging your primary home equity for an investment property purchase makes good financial sense, here are some tips:

• Shop around for the lowest rates and fees – Compare multiple lender quotes to find the best offer.

• Choose the longest term possible – Longer terms of 15-20 years result in lower monthly payments.

• Don’t borrow more than 80-85% total combined loan-to-value – This helps preserve equity in your primary home.

• Have a large enough emergency fund – Maintain savings to cover both mortgage payments if needed.

• Get quotes for both a home equity loan and cash-out refinance – Compare costs and rates to see which works better.

• Claim the tax deduction for interest if using funds for property expenses – Consult your CPA to maximize deductions.

When Does it Make Sense to Use Home Equity for Rental Loans?

Here are a few scenarios when tapping into home equity for real estate investing can be advantageous:

• You have a solid emergency fund and stable income to manage the additional payment.

• You need funds quickly and have limited cash reserves. Home equity loans fund faster than alternatives.

• You have prime credit (690+ score) and at least 15-20% equity available to tap.

• You can get a home equity loan rate that’s at least 2% lower than credit cards or personal loans.

• The rental property has strong profit potential that exceeds the loan interest.

• You want to keep your current low mortgage rate instead of refinancing.

What are the Best Home Equity Loan Lenders?

If you decide to go the home equity loan route, choosing the right lender is key. Here are some top options to consider:

• Rocket Mortgage – Top online lender with a fast and easy application process. Offers competitive rates and terms.

• Lightstream – Provider of home equity loans nationwide. Offers fixed rates as low as 5.99%. No home appraisal required.

• SoFi – Leading fintech lender with low rates and flexible terms on home equity loans. Soft credit pull preapprovals.

• Citibank – Major national bank offering home equity loans and lines of credit. Discounts available for existing customers.

• Wells Fargo – Traditional lender with physical branches across the U.S. Streamlined approval process for account holders.

No matter which lender you choose, be sure to get multiple quotes and compare all costs and terms before moving forward with a home equity investment loan. Consulting a loan officer or financial advisor can also help you make the most informed decision based on your unique situation.

Alternatives to Home Equity Investment Loans

While tapping home equity is one financing option for rental properties, it’s not the only one. Here are a few other possibilities to consider:

Cash-out refinance – Refinancing your primary mortgage into a larger loan results in cash back at closing. This combines your debts into one payment.

Hard money loans – These short-term, high-interest loans are backed by the property itself rather than your credit or income.

Private money loans – You can borrow from individuals like friends, family, or private investors rather than institutions.

Business lines of credit – Some banks offer lines of credit or loans specifically tailored for real estate investors.

Crowdfunded real estate loans – Borrow from a pool of investors via an online lending platform.

401(k) or IRA funds – You may be able to use retirement savings for rental property purchases through specialty loans.

Low-down payment conventional loans – Some lenders offer mortgages requiring as little as 3-5% down for investment properties.

Weighing the Pros and Cons

As you can see, leveraging home equity for rental property investment loans has both advantages and disadvantages. It’s important to carefully consider your entire financial situation.

While home equity loans can provide fast access to capital at affordable rates, you also take on risk by borrowing against your primary residence. Crunching the numbers to analyze potential returns versus costs is key.

Most importantly, never tap so much equity that you end up owing more than your home is worth. This can lead to being underwater on your mortgage. Consulting a trusted financial advisor can help guide your decision, based on your individual circumstances.