As an investor, access to additional funds for a downpayment can help purchase new rental properties and open new revenue streams. And as a person, access to extra funds for education, medical expenses or debt consolidation can make sense. One possible source of those funds? A home equity line of credit (HELOC).
A HELOC allows you to borrow money from a home’s equity during a draw period, usually 10 years. HELOCs are available with variable and fixed rates, although variable-rate HELOCs are more common.
Can you take a HELOC on an investment property, for example, to fund major renovations? Yes, you can. Read on to understand HELOCs on investment properties and whether leveraging investment equity makes sense.
What Are HELOCs on Investment Properties?
When you build equity in a property, you could potentially tap into that equity through a HELOC. HELOCs are revolving lines of credit that use your home as collateral. You’ll usually pay less in interest on a HELOC than on a credit card or even on a personal loan.
With a HELOC, you’ll have a draw period to use the credit line and only make low-interest-only payments. For most HELOCs, the draw period is 10 years. After the draw period, you’ll be responsible for repaying the balance through monthly payments, usually with variable interest rates.
A HELOC on an investment property functions like a HELOC on your primary residence. The only difference is that the rental property is used for collateral. You can usually apply for a HELOC when you have at least 15% to 20% equity in the home.
How Are HELOCs on Investment Properties Different From Homes?
The difference between HELOCs on investment properties and HELOCs on homes is the risk they present. A HELOC on an investment property uses that property as collateral. That means that if you default on the loan, you don’t risk losing your primary residence.
The basic function of a HELOC on investment property or a primary residence is the same. It’s a revolving line of credit that can be tapped into whenever you like for everything from home renovations to debt consolidation or medical payments.
What Are the Requirements to Get a HELOC on an Investment Property?
The requirements to qualify for a HELOC on an investment property vary by lender, but generally, you will need a minimum credit score of 700. You also will need a debt-to-income ratio of 43% less. The maximum loan-to-value ratio on the property is 80%. Lenders may accept a higher debt-to-income ratio in cases of proof of greater expected rental revenue.
How to Get a HELOC on an Investment Property?
If you decide that a HELOC on an investment property is the right for you, here are the steps to take.
1. Research Lenders
Start by researching and identifying lenders who offer HELOCs specifically for investment properties. You can easily compare multiple online lenders and contact local banks or credit unions. Carefully compare interest rates and terms to find the lender that offers the best opportunity.
Also, check whether the lender will give you the funds as a lump sum or a credit line you can access. Whether you need the full value upfront may affect the lender you choose.
2. Determine the Equity in the Investment Property
Calculate the equity in your investment property by subtracting the outstanding mortgage balance from the property’s market value. For example, if the property’s market value is $150,000 and the outstanding mortgage amount is $80,000, the equity in the property is $70,000.
3. Gather Necessary Documentation
To apply for a HELOC, you’ll need documentation about income and expenses. Plan to come prepared with proof of income, tax returns, rental agreements and proof of property insurance.
4. Apply for the HELOC
You can apply for a HELOC online or by visiting the lender’s physical location. A HELOC application usually requires basic information such as your name, address and Social Security number plus information on income and revenue potential for the property.
5. Wait for Approval and Receive the Funds
Once your application is approved, you will receive a formal approval letter outlining the terms and conditions of the HELOC. Read these carefully to ensure you understand interest rates and repayment terms. After accepting the terms, you'll receive the funds either in a lump sum or in the form of a credit line that you can access as needed.
Pros of HELOCS on Investment Properties
HELOCs on investment properties have numerous advantages, from low interest rates to reduced risk, compared to a HELOC on your primary residence. Here are the pros:
Quick Access to Funds
HELOCs offer quick access to funds, allowing investors to take advantage of investment opportunities or cover unforeseen expenses without delays. From home repairs to house flipping to funds for the downpayment on new investment property, HELOCs offer flexible funding to keep your business moving forward.
Lower Interest Rates
HELOCs typically have lower interest rates than other financing options, making them more cost-effective for accessing funds for investment properties. In addition, during the draw period, you typically only need to pay interest without repaying the principal, offering additional financial flexibility.
Property Appreciation
HELOCs are an option to leverage existing equity to build your business. By using a HELOC to invest in property improvements or to purchase additional properties, investors can potentially increase the value of their investments over time, leading to potential appreciation and higher returns.
Cons of HELOCs on Investment Properties
HELOCs come with a few major risks you should carefully consider before going ahead.
Risk of Foreclosure
If you cannot make the required monthly payments on your HELOC, there is a risk of foreclosure on your investment property. This can lead to greater losses as well as the loss of monthly cash flow. To avoid this risk, make sure you make all HELOC payments on time or early.
Negative Cash Flow
If the property does not generate enough income to cover the monthly payments, you may have negative cash flow. In this case, you’ll have to pay the difference between income and the HELOC repayment from other funds, cutting into your available capital.
Increased Debt Risk
Taking on a HELOC on an investment property adds to your overall debt load. This can make it more difficult to get approved for other mortgages and loans and increase the overall risk of default.
Get the Best HELOC with Benzinga’s Top Mortgage Lenders
If you’re ready to go ahead with a HELOC, you can start by checking out the offers from Benzinga’s top mortgage lenders:
Getting HELOCs on Investment Properties
While there are pros and cons to HELOCs on investment properties, if you need an infusion of cash, the pros usually outweigh the cons. HELOCs typically have lower interest rates, and you can use the funds on anything you want. In addition, by putting the HELOC on an investment property, you avoid risking your primary residence. Ready to get started? Compare HELOCs versus refinance options here.
Frequently Asked Questions
How much can I borrow with a HELOC on an investment property?
On an investment property, you can usually get a HELOC up to a maximum loan-to-value ratio of 80%. That means that if the home is worth $100,000, the maximum available HELOC would be $80,000.
Can I deduct the interest from a HELOC on my investment property for tax purposes?
Interest from a HELOC can be tax deductible if you meet certain requirements. For example, the funds can only be used for home upgrades or renovations.
What are the repayment terms for a HELOC on an investment property?
Repayment terms on HELOCs vary, but generally, the draw period is five to 10 years, while the repayment period is typically 10 to 20 years.
About Alison Plaut
Alison Plaut is a personal finance and investing writer with a sustainable MBA, passionate about helping people learn more about wealth building and responsible debt for financial freedom. She has more than 17 years of writing experience, focused on real estate and mortgages, business, personal finance, and investing. Her work has been published in The Motley Fool, MoneyLion, and she regularly contributes to Benzinga.