How to get a home equity loan on an investment property

Successful real estate investors use a wide range of tools to deftly maneuver and seize new investment opportunities. One of those funding tools is home equity loans; although popular for homeowners for their primary properties, home equity loans can also be used by real estate investors. There is a trick to getting home equity loans on investment properties, but a savvy investor can use this tool to cover expenses and shortfalls – or even invest in purchasing additional homes. We’ll cover how home equity loans on investment properties work so you can decide whether it’s right for your next portfolio upgrade.   

What is a home equity loan?

A home equity loan is a type of debt taken out against the equity you have in a property, whether your primary residence or an investment property. Unlike a home equity line of credit (HELOC) that allows you to borrow as needed during a set time period, a home equity loan will offer you a single disbursement of funds at the start of your loan. You’ll repay this debt with monthly payments over the course of five to 30 years at a fixed interest rate. Home equity loans come with a predictable payment schedule, which can make them more attractive to investors looking to project their costs. 

Can I get a home equity loan on an investment property?

Typically, home equity loans are made against someone’s primary residence. Lenders that offer home equity loans for non-owner-occupied homes are a bit tougher to find, but it’s possible if you’re creative in where you look. Credit unions are often a fruitful source of home equity loans on investment properties, for example – especially if you already have a banking relationship with the institution in question. 

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The requirements to get a home equity loan on an investment property tend to be a bit more strict, and they often come with higher interest rates than you’re used to for normal home equity loans. Lenders take on a bit more risk in offering these loans, after all; borrowers that fall on tough times may not be as motivated to repay a home equity loan on an investment property as if it were their primary home. 

Requirements for getting a home equity loan on an investment property

In order to get approved for a home equity loan on your investment property, you’ll need to meet these qualifications. Remember, the bar to get approved is a bit higher than for home equity loans on your personal home, so these parameters will look different than you may be used to if you are familiar with home equity loan requirements:

Credit score

You may be able to get approved for a home equity loan with a credit score of 620 (or even less) for your own personal residence. However, when you’re talking about an investment property, most lenders won’t work with you unless your credit score is 700 or higher. It may be difficult or impossible to get approved for a home equity loan or HELOC on an investment property if you have bad credit. 

Loan-to-value (LTV) ratio

Lenders aren’t typically as generous in how much they’ll fund for a home equity loan on an investment property vs. an owner-occupied home. With a personal home equity loan, for example, you may be able to borrow up to 80% (or even 100%) of your home’s value, less the amount of any mortgage. 

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If you’re looking for a home equity loan on an investment property, however, you may only be able to borrow up to 60% to 75% of your property’s value. That means that unless you’ve made significant progress in paying down any other debts attached to that property, you may not even be eligible for a home equity loan for a while — or at least an amount worth borrowing.

Debt-to-income (DTI) ratio

Lenders generally tend to look for the same debt-to-income ratio for a personal home equity loan as opposed to a home equity loan for an investment property: 43% or less. A DTI ratio measures what percent of your total monthly income goes towards debt payments, and — more broadly — it indicates whether you have a suitable amount of wiggle room in your budget to afford to make payments on a new home equity loan.

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Cash reserves

Having a sufficient amount of cash reserves in place can ease many lender’s minds about your ability to repay the loan. That’s why some lenders require that you have at least six months of expenses in place to cover any long-term vacancies or other setbacks. 

Rental history

If your property is currently being used as a rental, lenders may want to see your income and expense history to verify the property’s ability to generate positive cash flow. Frequent vacancies can be a red flag for potential lenders. 

Alternatives to home equity loan on investment property

A home equity loan can be the perfect tool to help you maintain or even grow your real estate portfolio, but it’s not the right option in every case. Here are a few other funding solutions to keep on your radar:

Cash-out refinance

Instead of taking out a separate loan for one small bit of your equity, some investors prefer to wrap their first mortgage and a home equity loan into one monthly payment via a cash-out refinance. This replaces your first mortgage with a larger one, allowing you to receive the excess funds back to use as you would a home equity loan. 

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A cash-out refinance loan can be particularly advantageous if you can qualify for a lower rate than you’re currently paying on your mortgage. It also allows you to amortize your funding needs over a longer period (up to 30 years), as opposed to the shorter terms more typical of a home equity loan. However, during a high-rate environment, a cash-out refinance can be prohibitive due to the increase in your monthly mortgage payments. 

HELOC

Home equity loans and HELOCs are very similar, except when it comes to how funding is made available and the payback costs. A HELOC is similar to a credit card, except your balance is secured by your home. Once approved for a HELOC, you’ll be able to borrow up to a set maximum limit, with more funds becoming available as you pay down your balance. Most often, HELOCs come with a variable rate, which makes the monthly payments less predictable than a home equity loan. However, you can borrow funds as needed, as opposed to a single burst of funds, as with a home equity loan. 

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A HELOC may work better for you if you’re looking for a backup source of flexible funds in times of emergency or to take quick advantage of sporadic investing opportunities. Opting for a HELOC means you won’t pay interest on any funds that you do not use. Often, HELOCs come with a lower, interest-only period during the initial life of the loan.  

Home equity investment

A home equity investment (HEI) is a non-debt source of funds tied to the equity in your home. Unlike a debt, you aren’t required to make monthly payments against an outstanding principal balance; instead, an HEI is designed to be repaid in 10 or 30 years as a percentage of the property’s equity appreciation. Homeowners generally repay HEIs when they sell their properties, or use savings or another debt product to pay off the amount due when the term comes to an end. 

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While many home equity investment products are not available for investment properties, investors can qualify for Point’s HEI, which has a 30-year term and no monthly payments. Like a home equity loan, an HEI for investment properties has slightly more stringent requirements than one for a primary residence. However, homeowners and investors can qualify for an HEI with credit scores above 500 and no income requirements. 

Final thoughts

The bottom line is that home equity loans can be a valuable real estate investing tool to keep in your back pocket. You’ll need to weigh many factors to determine if it’s the right time to deploy it. Here are a few reasons why you might choose a home equity loan over another option:

• You don’t want to tap into your cash reserves.
• You want to pay off the debt more quickly than with a longer-term option, such as a cash-out refi. 
• You’re looking to hold onto the property for the long term since home equity loan liens can complicate home sales. 
• You have a specific purchase or project in mind you’d like to complete, such as a down payment on a new investment property or rehabbing your current property. 

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If a home equity loan is not the best fit for you, check if your property is eligible for a Home Equity Investment from Point.