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HELOC stands for “home equity line of credit.” HELOCs are often used by homeowners to tap into the equity they’ve built up in their home to finance a major purchase, to fund home improvements, or as a source of cash for other purposes.
Owners of investment properties can also consider a HELOC on their equity in that property. However, a HELOC against an investment or rental property can be more difficult to get in some cases compared with a HELOC against a personal residence.
A HELOC on an investment property might be a good idea if the money will be used to make improvements or repairs on the property. These uses may allow the interest on the loan to be tax deductible. Other uses may have merit, but potential borrowers will want to “run the numbers” to determine if a HELOC is their best option.
Requirements to get a HELOC on investment property
The requirements to get a HELOC on an investment property will vary from lender to lender. Some of the basic metrics lenders will look at regardless of whether the HELOC is for a personal residence or and investment property include:
- The amount of equity you have in the property. This is measured by the loan-to-value (LTV) ratio. Typically, a lender will want an LTV in the 75% to 80% range for an investment property. This means that any outstanding loans on the property can’t exceed 75% to 80% of the value of the property. Lenders may go up to a 90% LTV on a HELOC for a personal residence.
- Your debt-to-income (DTI) ratio. DTI is calculated by taking the applicant’s total monthly debt obligations by their monthly income. Lenders want to be sure that tapping into the HELOC will not cause you to be overextended in terms of your debt obligations. The acceptable range is 40% to 50% for an investment property.
- Your credit score. This is a record of how well you pay off your debts and can be an indicator to a lender whether or not you are a good credit risk and worth lending to. You will need at least a score of 720.
- Your personal cash reserves. This may be a factor that a lender will consider in deciding whether or not to extend the HELOC. These reserves can help ensure that you will have adequate cash to pay off any part of the HELOC you use in the event that your financial situation takes a negative turn. You usually must have at least six months’ worth of expenses.
Pros and cons of getting a HELOC on an investment property
| Pros | Cons |
|---|---|
The interest rate on a HELOC might be lower than on other forms of financing, such as using a credit card or an unsecured home improvement loan to cover the cost of improvements or repairs on the rental property. | The interest rate for a HELOC on an investment property may be higher than the rate on a similar HELOC for a property that serves as a personal residence. This is because a loan against an investment property is considered to be riskier than one against a property that serves as a personal residence. |
A HELOC is a flexible line of credit that can be tapped on an “as needed” basis. Interest is generally due and payable only if there is an outstanding balance on the HELOC. | HELOCs on investment properties can be harder to find than one for a personal residence. |
A HELOC on an investment property can be less risky than one on your personal residence in that if you default on it, your home is not at risk of foreclosure. | If the value of your investment property declines, you could find yourself underwater if you try to sell the property based on its reduced value while having a significant amount outstanding on the HELOC. |
How to get a HELOC on investment property
Getting a HELOC on an investment property is generally more difficult than getting one on your personal residence. First, not all lenders who offer HELOCs on a residential property offer them on an investment property. Second, the requirements are usually more stringent, as lenders consider these loans riskier. A borrower is less likely to default on a loan against their own home than one against a rental property, or at least this seems to be the thinking.
Some of the lenders often mentioned as solid choices for a HELOC on an investment property include:
- Fifth Third Bank
- PenFed Credit Union
- TD Bank
There are other lenders in the residential HELOC space to consider as well, and these lenders may also offer HELOCs on investment properties. It can make sense to start with your own bank or credit union to see what it offers or if it can make a recommendation to another lender if it doesn’t offer HELOCs on investment property.
Alternatives to a HELOC for an investment property
There are a number of alternatives to getting a HELOC on your investment property. They include:
A HELOC on your primary residence
Getting a HELOC on your primary residence may be easier than getting one tied to an investment property. There is typically a larger pool of lenders willing to extend these lines. Interest rates are often lower and the LTV limits may be higher.
The main downside to getting a HELOC on your primary residence and putting the funds to use on your investment property is that if you default, you are potentially putting your home at risk of foreclosure.
Home equity loan
This is a regular loan in which you would receive a lump-sum payment at the time the loan is approved. Your collateral for the loan would generally be the amount of equity you have in the rental property. As with a HELOC on an investment property, a home equity loan on an investment property might come with a higher interest rate than one against a residential property, and there may be fewer lenders out there who are willing to extend a home equity loan against a rental property.
Unsecured personal loan
This is a loan based on your own credit history and financial qualifications. This type of funding is typically quick, and there is no issue of collateral or other related factors. One downside is that payments on the loan often start almost immediately, and you will need a solid credit score and personal financial history to qualify. You will want to research the best personal loans as part of the process of deciding whether a personal loan is a viable option for your situation.
Cash-out refinance
A cash-out refinance involves refinancing the mortgage on the rental property at a lower rate, with a loan for a shorter term, or both. With a cash-out refinance, you can withdraw a portion of the property’s equity as part of the process. The amount withdrawn and the outstanding balance on the prior loan are added into the new loan. The cash-out feature allows you to access a portion of the property’s equity to apply to repairs or improvements on the property. It can also be used forother purposes.
As this type of refinancing typically is more popular when interest rates are low, the current higher rate environment we find ourselves in might make this option less attractive.
Credit cards
Using a credit card can be a means to cover the cost of repairs or improvements to an investment property. Depending upon the interest rate on your card, this can be an expensive means of financing these costs. This assumes that you will not be able to pay off the full amount on the card by the appropriate due date to avoid interest charges.
Additionally, tying up all or much of your credit limit on the card can cause an issue if you need to cover the costs of an unexpected emergency expense with the card. This might be unexpected medical costs, expenses related to a car accident that are not covered by insurance, or a host of others. This may be a good time to search for the best credit cards.
How to determine which product is best for your situation
When looking for ways to get cash for repairs, updates, or improvements on an investment property, there are a number of factors to consider when deciding between a HELOC and other options.
A HELOC on your investment property is a good option in that the debt is tied to that property and not your personal residence. If you can find a lender who offers a HELOC on a rental property at favorable terms, this can be a solid option.
Credit cards can be a good alternative in that there is no delay in getting the cash. If you are able to pay off the balance quickly, this frees up the card for other expenses and will help you avoid high interest costs. Whether this is a viable option will also depend on the cost of the repairs or improvements needed on the property.
A cash-out refinance can be a good option if you can refinance at a lower rate than the current loan on the property. You don’t want to add a second monthly payment to your obligations.
A personal loan can be a good option if you don’t want to use the investment property as collateral and can secure the loan at a good rate.
Overall, everyone’s situation is different. If you are looking for a borrowing method to get money to put into your rental property to maintain or enhance its value, you will want to look at a number of options while taking your overall financial situation into account. Some things to consider:
- Does your bank offer HELOCs on investment properties? If so, does it do so on favorable terms?
- Are there other lenders who might be able to accommodate your needs?
- Weigh the pros and cons of a HELOC on your investment property versus other forms of borrowing or otherwise obtaining the cash needed.
- Be sure that the money obtained from the HELOC or other type of financing on your rental property will be put to good use in terms of providing you with a future benefit. This might be enhancing the value of your rental property through improvements, using the money as a down payment on another investment property, or other purposes that can offer a financial benefit down the road.
TIME Stamp: A HELOC on investment property can be a good financing source
A HELOC on your investment property can help you finance improvements, repairs, a down payment on another rental property, or other purposes. It can make sense to tap the equity in the property, especially if you will be putting the money back into it.
A HELOC on an investment property can be more difficult to obtain, so it pays to shop around. It also pays to look at other types of financing in order to allow you to make the best choice for your situation.
Frequently Asked Questions (FAQs)
Can I use a HELOC on a rental property?
You can certainly use a HELOC on a rental property. Note that the number of banks who offer HELOCs on an investment property is smaller than those who offer HELOCs tied to a personal residence.
You should also take a step back to determine if a HELOC on your rental property is the best option for your situation and needs. This will vary from borrower to borrower.
Can I get a HELOC for a second home?
A second home, such as a vacation home, may be eligible for a HELOC depending on the rules of the particular lender you are considering. As with a HELOC on your primary residence or a rental property, look at all of the factors, including the interest rate, what you intend to do with the money, and if the cost of the HELOC is justified for you.
How is a HELOC on an investment property taxed?
The Tax Cuts and Jobs Act effective for the 2018 tax year changed the tax deductibility rules surrounding a HELOC, including a HELOC on an investment property. The money from the HELOC must be used for home improvements or repairs, and the combined amount of mortgage debt, home equity in use, and other debt cannot exceed a combined $750,000 for those married and filing jointly . As the deductibility rules can be complex, it is always best to consult with your tax advisor to be sure about any deductibility.
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