Investing in rental property is a lucrative venture — one that offers the opportunity for passive income and long-term wealth. Your rental property can also help you access cash when you need to meet other financial goals.
A home equity line of credit (HELOC) is just one tool you can use to tap into your rental property for liquidity. In this comprehensive guide, we'll explore the ins and outs of obtaining a HELOC on a rental property, from understanding eligibility to navigating the application process and weighing the pros and cons.
HELOC: A quick overview
A HELOC is a type of second mortgage secured by the equity in your home. It offers a revolving line of credit that works similarly to a credit card.
During the draw period, typically ten years, you can borrow as much as you need to, up to a set limit. You’ll be responsible for interest-only payments during this time. However, you can pay down the balance to free up more cash as you’d like.
Once the repayment period begins, your balance becomes a principal-plus-interest loan. You'll be responsible for monthly payments over a term that is generally up to 20 years.
Since your home serves as collateral, you'll get a better rate compared to other debt products, like an unsecured personal loan. However, HELOCs have variable interest rates, which means monthly payments may fluctuate with market conditions.
There are no restrictions on how you can use your funds, allowing you to:
- Renovate your rental property
- Tackle deferred maintenance
- Pay off any property taxes or debts
- Invest in a new property
How a HELOC on rental property differs from a HELOC on a primary residence
Although taking out a home equity line of credit on rental property works similarly to getting a HELOC on your primary home, some considerations make it more challenging.
Qualifying is harder
Requirements for HELOCs on investment properties are more stringent. You'll need to be in excellent financial health to qualify.
Most lenders will require:
- A loan-to-value ratio (LTV) of no more than 75% to 80%
- A credit score of 720 or higher
- A debt-to-income ratio (DTI) below 43%
- 20% equity maintained after the HELOC is withdrawn
- A cash reserve that can cover up to six months' worth of payments
- Information about tenants and rental income
They cost more
You’ll be on the hook for larger HELOC-related expenses, including higher interest rates, fees, and closing costs.
Lenders are harder to find
Since your cash flow is spread between multiple homes, lenders generally find non-residential homes a riskier investment. As a result, you’ll need to spend some additional time searching for a lender willing to approve a HELOC rental property application.
How to take out a HELOC on rental property
Check your financial health
Give your financial situation a thorough assessment. You’ll want to gauge your eligibility and evaluate how a HELOC will impact your finances. This involves taking a hard look at your rental income, property expenses, and cash reserves to ensure you can comfortably manage payments in the near and long term.
If you’re on the brink of eligibility, take the time to improve your credit score, lower your debt, or boost your income. Otherwise, explore alternative options.
Shop around and compare lenders
Finding a lender may be tricky, but it's still worth shopping around for the best offer. Take the time to research and compare — looking beyond just interest rates, consider loan terms, fees, and customer service reputation.
You can request quotes from multiple lenders or even prequalify.
Apply and go through the process
Once you've honed in on a lender, prepare to formally apply. After submitting your application, you’ll go through the underwriting process — which is where a lender assesses your eligibility. This will involve verifying your income, evaluating your creditworthiness, gauging your ability to repay the loan, and completing an appraisal of your home.
Getting the necessary documents ready ahead of time can help streamline the process and get you funded faster. Some general documents you can expect to provide are:
- Income verification
- Property information
- Tax documents
- Rental history
Receive your funds
After applying for a HELOC, it can take two to six weeks to receive your funds. In most cases, you’ll have a line of credit. However, some lenders will allow you to withdraw a lump sum.
Is it a good idea to take out a HELOC on rental property?
There are several pros and cons to consider when determining if a home equity line of credit is right for you.
Pros of getting a HELOC on rental property
You can make rental improvements
One significant advantage is the ability to fund necessary home improvements on your rental property. Whether updating the kitchen, renovating the bathroom, or enhancing curb appeal, you can accomplish what you need without straining your cash flow. As an added benefit, the interest paid on your HELOC may be tax-deductible when used to improve the property.
You can raise your ROI
Investing in home upgrades is one of the easiest ways to boost your property's value. Furthermore, improving the property's appeal and functionality can also justify raising the rent — increasing your rental income and overall return on investment!
There's the potential to diversity your portfolio
A HELOC can help increase your liquidity without you having to sell the property. You can then use your funds to purchase more real estate or invest in other opportunities, like a business or stocks.
The cons of getting a HELOC on rental property
You'll be more financially vulnerable
Ultimately, a HELOC is not just a loan but a long-term financial obligation. While interest-only payments during the draw period may seem like a small burden — larger monthly payments will eventually kick in.
This can significantly strain your finances if rental income fluctuates or unforeseen expenses arise. For example, vacancies or tenant turnover can disrupt your cash flow, resulting in the need for more debt — or worse, defaulting on the loan.
You risk an underwater mortgage
There's no guarantee your property will appreciate. In fact, home values are susceptible to market fluctuations and economic downturns. If you find yourself owing more on your property than it’s worth, you'll have negative equity — which can limit your ability to refinance or sell the property.
You risk losing the property
Defaulting on payments or failing to meet the terms of the HELOC agreement could lead to foreclosure. A foreclosure will not only result in losing the property, but it also damages your creditworthiness as an investor.
Alternative options
HELOC on your primary residence
Getting a HELOC on your primary home rather than a rental property will help loosen the qualification requirements and increase the pool of lenders willing to approve you.
In addition to being more accessible, HELOCs on primary homes offer more reasonable rates and terms.
Home equity loan on your primary residence
A home equity loan is another type of second mortgage that allows you to tap into your equity for a lump sum of cash. You'll have to repay the loan plus interest in set monthly payments over a 5 to 30-year repayment term. Home equity loans offer fixed rates, which protect you from market fluctuations.
While you can take out a home equity loan on an investment property, the challenges are similar to those of a HELOC on an investment property. Therefore, leveraging your primary residence will be easier and more cost-effective.
Requirements:
- Credit score: 620 or higher
- CLTV: 80-85% or lower
- DTI: 43% or lower
Home equity investment on your primary residence or rental property
A home equity investment (HEI) offers a lump sum of cash in exchange for a share of your home's future appreciation. There are no monthly payments. Instead, you repay your investment anytime during a flexible 30-year term when you decide to sell or refinance.
A home equity investment works the same on a primary residence or rental property.
Requirements:
- Credit score: 500 or higher
- LTV: 70% maximum
- No DTI or income requirements
Personal loan or 0% APR credit card
Depending on how much cash you need, a personal loan or credit card may offer a more cost-effective solution. Unlike equity financing tools, they have fewer fees and upfront costs.
Personal loans offer fixed interest rates and predictable monthly payments. To determine if they're right for you, calculate the total cost of the loan compared to that of a HELOC. Also, consider whether the monthly payments fit into your immediate budget.
Conversely, 0% APR credit cards offer an introductory period during which no interest is charged. If your budget can support paying off the entire balance before the promo period, a credit card may be a helpful solution.
Cash-out refinance on your primary property
A cash-out refinance replaces your primary mortgage with a larger one and lets you pocket the difference in cash. Unlike a home equity loan, you'll have only one monthly payment—a larger mortgage payment.
You'll get new mortgage terms and a new rate when you refinance. Therefore, this option makes sense if you can secure a lower rate and better terms than your current mortgage.
Like a home equity loan or HELOC, getting a cash-out refinance on an investment property comes with more stringent requirements, costs more, and offers few lenders.
Requirements:
- Credit score: 620 minimum
- CLTV: 80% or less
- DTI: 45% or less
The bottom line
A home equity line of credit is a valuable tool to have up your sleeve. With the extra liquidity, you can finance improvements and increase your ROI — or invest in another rental property and diversify your portfolio. To make the most of securing a HELOC on a rental property, be diligent in your search for lenders; you'll want to find the best terms and rates.
For property owners who want a more affordable solution, consider tapping into your primary home's residence for a better rate or exploring a home equity investment. As with any financial decision, thorough research is crucial to making informed choices that align with your long-term goals.
Achieve your financial goals with a Home Equity Investment from Point. There are no monthly payments and no need for perfect credit. See what your home could do for you with no impact on your credit score.
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