Rental property owners and residential property owners may sometimes need to source a lump sum of money. It’s easy for property owners to get loans such as a home equity loan or a HELOC loan. However, rental property owners and investment property owners often worry about using HELOC on investment properties.
The answer is yes, you can use HELOC on an investment property. The benefits of using HELOC on investment property stem from the fact that you'll be using equity which the property has built over time to get funds for other things.
It’s therefore pertinent that real estate investors have a working knowledge of how to use HELOC on an investment property. In this article, We’ll not only be looking at what HELOC is, but you’ll also get a comprehensive guide on how to use HELOC as a real estate investor.
What is HELOC?
HELOC is an acronym for a home equity line of credit. It's a line of credit consolidated by the equity in your home, which gives you access to a line of credit that you can use for significant expenses. The interest rates for HELOC loans are considerably less when compared to other loans.
HELOC often has a draw period of ten years, and at this time, you can borrow any amount you want. After the draw period ends, the repayment period, which is generally up to 20 years, begins. Your house is the collateral for the loan.
So instead of paying out in full at closing like an average mortgage, a HELOC is a lender’s promise that the lender will advance the borrower's loan for a set amount of time of the borrower's choosing. The market value of your property decides how much you can take out in HELOC.
For instance, if your property value is $500,000 and you’ve paid up to $300,000 in mortgages, you may qualify for $40,000 to $140,000 dollars in HELOC. It all depends on your credit score. An excellent credit score increases your eligibility.
How to Qualify for a HELOC Loan
To qualify for a HELOC loan, the value of your home must be higher than the amount you owe in debt on your home. Maintaining excellent credit scores will help too. Lenders tend to consider things like your credit and employment history, also your monthly income and debt.
You’re more likely to qualify if you have a good credit score. Your debt to income ratio also matters a lot. HELOC lenders will look over your credit report and outstanding mortgage balance before approving the loan.
Can I Use HELOC for Investment Properties?
Many investors borrow money to buy a property. A home equity line of credit is an excellent financial tool to use because it utilizes existing equity that might otherwise be stagnant. What’s more? You can choose when to draw on the credit line. This way, there’s no need to pay interest on a loan that you’re not using. So yes, you can use HELOC for investment property.
Right now, in real estate investing, many investors utilize it to buy a new investment property or rental property when they become available. Besides being cheaper, it’s more convenient because it doesn’t take as much time to close as a personal loan.
How to Use HELOC Loan on Rental Property
To effectively use HELOC on a rental property, you’ll need to engage the services of a HELOC lender who specializes in investment property line of credit. It typically comes with a higher interest rate than if it were for a primary residence.
Rental property HELOC is a valuable alternative financing source in real estate investing. If you’re a savvy investor, you can get a HELOC on your primary residence to pay off an existing mortgage on your investment property. Likewise, you can get HELOC on an already existing rental property to finance the acquisition of new rental properties.
It is, however, essential to know that getting an investment property HELOC may prove difficult. Banks are more inclined to give HELOC to primary homeowners, and the default rate for owner occupied property is generally lower than investment property HELOC.
Can You Use HELOC to Make Down Payment for an Investment Property?
Savvy real estate investors can use HELOC to make a down payment for an investment property or a rental property. Using HELOC on an investment property is a fantastic way to cover down payment fees.
So you can either take out HELOC from primary residences or another rental property to buy an investment real estate property if you don't have enough cash reserves. Compared to other loan options available in real estate investing, rental property HELOCs are the intelligent way to grow your investment portfolio.
There are also tax advantages when you take a HELOC on a rental property because the interest rate is tax-deductible. However, because banks hold a higher credit standard for rental property HELOC and investment properties generally, homeowners with multiple properties are more likely to accept default payment on investment property than their primary residence.
HELOC vs. Home Equity Loan
The primary difference between home equity loans and HELOC is that while a home equity loan offers borrowers one lump sum of money to be paid back over an agreed period, a home equity line of credit is a revolving line of credit.
Another difference is the repayment periods. A home equity loan is over a fixed period and has a fixed interest rate. A HELOC, on the other hand, allows a borrower to tap into the equity of their property up to a specific credit limit.
A home equity loan is often referred to as a second mortgage, and you can borrow up to 85 percent of the home’s equity. Home equity lines of credit typically have more variable interest rates; however, some lenders offer fixed interest rates.
In both cases, securing the loan depends on how much equity your property has accumulated over the years since the loan and line of credit are secured against the house. A higher credit score will also give you an edge in both cases.
Home equity lenders offer anything ranging from five to 30 years as a repayment period for loans. However, the amount to be made in the monthly payment is fixed and can't be changed. If you know exactly how much you need to invest, then this loan is ideal.
However, one must be careful when taking out HELOC funds or home equity loans. If you’re unable to meet monthly payments in the case of home equity loans, you may likely lose your property.
HELOC vs. Cash-out Refinancing
A cash-out refi or cash-out refinance pays off your first mortgage and leaves you with a new mortgage that may have different terms from your previous mortgage. It incurs closing costs that are almost the same as your original mortgage. The equity on your property must have built up considerably for you to use cash out.
While a cash-out has a lower interest rate than HELOC or home equity loan and has multiple loan choices available, it extends the time frame for paying your mortgage off. You may end up with closing costs associated with refinancing. More so, you may end up with a high interest loan, and an increased interest loan means a larger monthly payment.
With a HELOC, you can borrow up to 85 percent of your property’s equity against 80 percent of a cash out refinance.
HELOC vs. Personal Loans
Personal loans are an alternative if you don’t want to use a credit line. A personal loan is an unsecured loan with a fixed repayment structure and interest rates. This kind of loan typically has a low interest rate against the variable interest rate of a HELOC loan.
Although a personal loan doesn’t require collateral, it doesn’t have any tax benefits, and you may be required to pay the origination fee. If your project requires a substantial amount of money, a personal loan isn't your best bet.
Most lenders have their unique repayment plans, but it usually spans from three to seven years. Since the loan is unsecured, there’s no risk of the lender taking your assets or home if you’re unable to meet your repayments.
HELOC vs. Credit Cards
HELOC and credit cards are similar because they’re both revolving types of credit, but they have different structures.
While HELOC is a secured loan, a credit card isn’t, which translates to higher interest rates. A HELOC comes with closing costs, while a credit card comes with abuse fees though not all of them.
The high interest rate attached to using credit cards makes it less ideal for real estate investment. Since it’s not tax beneficial like a HELOC, it might end up complicating your transaction in the future.
It’s more advisable to use credit cards for personal purchases and expenses. Though conversely, you can use your credit card to pay off HELOC debt or use your HELOC to pay off credit card debt, it should be as a last resort.
HELOC vs. Home Sale-Leaseback
Home sale-leasebacks are relatively new in the market, and newbies who are venturing into real estate investment may consider this an option. Here, you sell your house to a company but continue to live there while paying rent.
The downside is that you don't have ownership of your house anymore. On the upside, you have a substantial amount of money to make an initial purchase of a new piece of real estate. Furthermore, you don’t have to pay off a loan with interest only subsequent rent.
Why You Should Use HELOC on a Rental Property
As a real estate investor, there are many advantages to using HELOC on a rental property that you should consider. Most real estate investors are always looking to acquire more properties while avoiding loans with high mortgage payments.
The unproductive equity on rental properties can be put to good use as HELOC on other investment properties or rental properties. It’s an ingenious way to build wealth.
Even if you qualify for a significant amount in HELOC, you don’t need to borrow all that money at once. You can withdraw money from your HELOC whenever a profitable investment opportunity arises.
There’s nonexistent or low closing cost, low-interest payments, and flexible repayment plans. Add that to the tax benefit associated with HELOC and the zero usage fee, and it’s perfect.
Using a credit line is just like a second mortgage, only this time, with more benefits. Your rental income will increase potentially if you have access to funds that’ll otherwise be redundant, and that’s a huge plus.
Things You Should Never Use a HELOC for
The temptation might be substantial, especially when you qualify for a considerable amount in HELOC to spend the money on other things such as using it to consolidate debt. It isn’t financially wise to do this as you’ll still be paying debts at the end of the day.
Using a HELOC to pay for a holiday or buy a car isn’t advisable. Though the interest payment is low compared to other loans, it's best to use your HELOC for making passive income.
If you’re looking to increase your rental income, a rental property HELOC will come in handy. It’s a superb tool to grow your net operating income steadily over time.
If you’re just starting out in real estate investment, you may want to explore your options first. However, it’s important to remember that the interest rate the lender grants depends heavily on the market value of the property and your creditworthiness.
Though there are many options for sourcing funds to invest in real estate, this is your best bet. However, you have to be cautious when using a HELOC. There’s a higher risk of losing your real estate collateral if you can't meet up your repayments. Therefore, make sure the loan is worth it or talk to a professional like Avery Carl of The Short Term Shop.