Although the securing of a home equity line of credit (HELOC) can pose some difficulties, the rewards are also worth the expenditure in time and resources. Using an investment property HELOC would allow investors to tap into assets that have succeeded in building up equity. Similarly, investors may profit from otherwise stagnant equity. It is somewhat of as an alternative source of funding to do any number of things: update your house, raise your credit, reduce debt, or even purchase a new property. At least, it is important for someone who wants to achieve a competitive advantage to understand how to use a HELOC on an investment property.
What Is A Home Equity Line Of Credit (HELOC)?
A home equity credit line is a homeowner loan with a maximum draw, as opposed to a fixed dollar sum, backed by the equity of the lender in their home (similar to a second mortgage). A HELOC is a lender’s pledge at the time of their selection to advance the lendee up to the agreed amount, as opposed to a normal mortgage that is usually paid out in full at the close.
Most HELOCs also set “draw” periods for the borrower to use the credit, and then another period for repaying the loan. Generally, borrowers are given five to 10 years where they are only expected to pay interest while repayment periods usually are 10 to 20 years. Credit lines borrowed against a home can be an invaluable resource, posing the question: Can I take a HELOC on an investment property? Or, if you’re already convinced, what banks are offering HELOC on investment property?
To be perfectly clear, investors can purchase HELOC on their investment property. Before doing so, however, they should know many things. As for banks willing to do that, investors need to shop around. While not every bank will allow owners to take out credit lines on their rental properties, there’s plenty out there who’ll; the rick is like regular loan shopping.
How Do You Use A HELOC On Rental Property
As soon as investors build up enough equity in an asset, a HELOC can become an invaluable source of alternative finance. A HELOC rental property can also turn into an ideal wealth-building strategy for experienced investors if handled correctly.
For one thing, investors may borrow money in one rental property against the equity to fund the purchase of another. Often, a HELOC can be used to finance home improvements for their rental property, much as a homeowner might do with their primary house. For their primary homes, smart investors can also get a HELOC to pay out mortgages on their primary residences, or even other high-interest debts.
In order to use a HELOC on rental properties effectively, investors have to resolve many obstacles. For example, banks are less willing to lend on investment properties, because owners are more likely to default on non-primary residential homes. Investors of rental property are less evident for the opportunity to remain current on a primary home. Investors may also have trouble applying for a HELOC. Lenders check out debt-to-income ratio, credit scores, other open accounts, and the cash reserve available to the lendee. Also if you have cash flow at your fingertips it doesn’t automatically make you the right choice.
Note that investors (and homeowners) who want to follow the HELOC route can consider qualifying for a line of credit on a primary residence simpler and more feasible.
Can You Use A HELOC For A Down Payment On An Investment Property?
A HELOC can be used to buy a real estate property. Basically, if you are going to use a HELOC on something, you might put it in a sound investment as well. After all, unleveraged equity is dead money and could end up costing you in the long run. Because of inflation mostly, stagnant equity that makes no interest or return on investment (ROI) is effectively throwing away assets. That said, it is almost always preferred to use equity to buy an investment property with a good gameplay for something else. Since a HELOC can use the home as collateral, ensuring the loan is worthwhile is crucial.
Home Equity Lending Vs HELOC
Home equity loans provide a lump amount of money to borrowers that the bank would expect to be repaid over a fixed period of time. A HELOC is a revolving credit line that can be tapped into anytime the borrower needs to.
Home equity loans (HELs) and HELOCs appear to have much in common at a glance. The similarities in their names alone are enough to leave those unfamiliar with their uses confused. However, it is worth noting that their similarities are just “skin deep.” Before they obtain one over the other, there are many distinctions between HELs and HELOCs investors need to know about.
The interest rates on each are, for example, different. Traditional home equity loans tend to be at a rate of fixed interest. On the other hand, HELOCs usually have variable rates which can have a dramatic effect on the amount owed over a long period of time. Aside from how interest rates are compensated for, the way each is paid is also different. Home equity loans tend to follow a payment schedule which is more organized. Simply put, these loans are usually paid back with a fixed monthly amount; with each repayment paying for both the principal and interest payments. On the other side, HELOC payments would be calculated by the sum the homeowner borrowers can charge towards their home and are subject to interest rate changes.
Primary Loan vs HELOC
A primary loan applies to a conventional mortgage taken out to buy a new home, while a HELOC on an investment property taps into existing equity. There are a number of key distinctions to remember to accurately compare the two choices.
For example, investors who tap into existing equity can find this option more costly compared with a conventional mortgage. As I mentioned earlier, the explanation for this is because HELOCs on investment properties are usually considered more risky than those on primary residences. Some lenders may require multiple assessments or longer waiting times before they approve a HELOC. Also, investors may find they can obtain lower interest rates compared to a mortgage.
This is not to suggest that a primary loan on an investment property is automatically the best option compared with a HELOC. Investors can and do draw on their current investments all the time, given the presence of some trade offs. Just remember to weigh carefully, before making a decision, the pros and cons of each option.
HELOC For Investment Property Costs
The costs associated with a HELOC are close to those of most other loans, including application, appraisal and attorney fees, for closing costs. In general, these costs vary between two and give percent of the overall loan. For example, if the HELOC rental property is at $20,000, the average costs of closing will be between $400 and $1000. In some cases, any or all of these fees will be waived by lenders but this is not assured.
A few extra costs to be mindful of include the possibility for an annual repair charge, non-use charges or early termination costs. Each such fee may vary from lender to lender, and may not apply in some cases. At the time of application and approval, investors will take note of any expense in order to prevent any surprises down the road.
Is HELOC On Rental Property Tax Deductible?
If the loan is backed by the corresponding rental property, the interest on the mortgage is a rental cost which can then be used to lower the taxable income.
How To Find A Lender For An Investment Property HELOC
The best way to locate a lender for a HELOC on investment property is to leverage your existing network. This is because not all lenders would award investment properties to HELOCs, making them a little difficult to find. Investors may ask mentors to know more about HELOC providers and other links. There will most likely be a few different choices, allowing investors to choose from the best approval conditions and interest rates.
Investors can also research lenders online or contact previous connections to see what options are available aside from word of mouth referrals. Although seeking HELOC providers for a primary residence is simpler there are lenders able to do the same for investment property.
How To Qualify For An Investment Property HELOC
Borrowers must meet three basic conditions to apply for a HELOC:
- Credit Score
- Debt-to-Income ratio (DTI)
Know Your Credit Score
When assessing a HELOC, lenders should pay careful attention to an investor’s credit score, as with most other sources of capital. After all, credit score is a common indication that a borrower is a risk, or not. As a general rule, the more likely an applicant is to apply for a HELOC the higher the credit score. It should be remembered, however, that an appropriate credit score doesn’t have a universal standard; different lenders have different standards. What one lender may consider to be a ‘healthy performance,’ another would find bad, or maybe even risky. Borrowers would usually want to boast a credit score of at least 740 if they want to tip the scales in their favor, but once again, everyone is different.
Know Your Debt-To-Income Ratio
Borrowers may want to show along with a decent credit score that taking out another loan won’t disrupt the balance between income and debt they already have. Banks will measure your debt-to-income ratio and see if, beyond what you already owe, you can afford to borrow more. However, unlike credit scores, lenders have set a precise minimum debt-to-income ratio: between 40 and 50 percent.
The single most important thing that someone wants to apply for a HELOC is equity. To be clear, a house has equity if the balance on the outstanding mortgage is less than the value of the house. Any borrower with equity in their home has also already met the initial qualifying requirements.
Top 5 Benefits Of Using A HELOC For Investment Property
When it comes to financial stability, a plan should be drawn up with both homeowners and investors. It can be a great choice for those who are financially stable to use the equity in a home or investment property to pay for home repairs or to cover unforeseen expenses (in the form of a HELOC) Keep on reading to find out more ways to use your home as a valuable resource.
- Finance Home Improvements: The funding of home improvement projects is one of the most important ways in which homeowners and investors use HELOCs. Indeed, the interest you pay on a home equity loan is typically only tax deductible by using the money on home-related ventures (i.e. not buying a new car or holiday ticket). If you are a homeowner in a position to rapidly pay off a loan, a great choice is to use a HELOC. However, if you believe that paying down the loan may take you longer than five years, a refinance or cash-out refinance may be your best bet if you can secure a lower interest rate.
- Consolidate Debt: Using your home’s equity is one of the easiest ways to reduce credit card debt, other debt or support the expenses that surround a family emergency. If unforeseen costs occur and you have no emergency fund in place, the use of a HELOC is an efficient way to easily access resources. Interest might not be a tax deduction (e.g. use a HELOC to compensate for medical expenses), but usually HELOCs do have lower interest rates than most debt reduction instruments. Paying that interest will probably also be cheaper than incurring taxes on capital gains that come from selling other investments, especially if you know you only need the funds for a short time.
- Move With Ease: If you’re a homeowner who’s planning to move but will need a little extra money to finance your new down payment (or other moving expenses), using your current home’s equity as a financial resource might be a wise step. Note however that if your home is already on the market, you usually won’t qualify for a HELOC; so be sure to plan ahead.
- Dip Into Savings: Fun fact: most Americans in retirement accounts and plans like 401(k)s bear the majority of their savings. Withdrawals from these accounts prior to age 59 1⁄2 are subject to income taxes and potential fines. Which means you’re not having the best bang for your buck if you’re a homeowner or investor who wants to withdraw capital early on for short-term expenses. And dipping into your HELOC may be useful if you need extra money before you retire.
- Improve Credit: The account will appear on your credit report when a lender accepts your HELOC application and you begin making payments on the loan. And guess what is the number one factor impacting your credit score… that’s right — your creditors payment history. Once you start making consistent payments, your score will likely improve. Additionally, if you use less than 30 percent of your credit spending limit line, your credit rating will improve.
Disadvantages Of Using A HELOC
Home Equity Lines of Credit have proven they can reward savvy investors with the funds they need, but that doesn’t mean there are no risks associated with borrowing against a home. To be perfectly clear, borrowing against a residence actually entails at least some significant disadvantages, which is why this strategy should be reserved for those who know exactly what they are getting into.
Undoubtedly, the single riskiest part of using a HELOC is to use a home as leverage. When a lender issues a HELOC, it secures the borrower’s home as collateral. As a result, failure to pay the loan could result in property loss. Any attempt to use a HELOC must be met with due diligence and the utmost ability to repay the loan; anything less is unacceptable.
Aside from guaranteeing the loan with a real property, HELOCs seem to come with a bit more complexity than most will consider. If nothing else, the rate on a HELOC can change. With variable rates, interest costs could increase sharply. Unsuspecting borrowers could have more expensive debt than they intended.
Alternatives To HELOCs
Although there are several advantages that come with using a HELOC on your home or investment property, there are still attractive alternatives to HELOCs. Below are only a few examples:
- Home Equity Loan: The only minor distinction between a HELOC loan and a home equity loan is how the borrowers can access their credit lines. HELOCS have an open-ended credit line similar to a credit card when usually carrying out a home equity loan.
- Cash Out Refinancing: Try refinancing your first mortgage if you can not use a HELOC which is effectively a second mortgage. When you take out a new loan that is bigger than your current one, you usually have cash left over to use it however you want (hence the term, “cash-out” refinancing). This strategy is a perfect alternative to HELOCs, if you can get a lower interest rate.
- Personal Loan: As most people talk about personal loans, they usually think about borrowing a few thousand dollars, but some personal loans will borrow up to $35,000 for individuals. Personal loans come with lower set-up costs than HELOCs and refinances, so you’re in luck if you need a little extra cash for only a short time. Nonetheless, bear in mind that such loans usually come with higher interest rates because the loan is not backed by an asset.
Using a HELOC on investment property can be a smart way to access alternative funding sources. The more investors know how to finance a deal the happier they’ll be, after all. At the very least, if the money is spent wisely, getting access to working capital is a perfect way to increase the bottomline.