A home equity line of credit (HELOC) is a popular way to leverage real estate assets to access cash. A HELOC is a revolving line of credit based on the equity you have in your property. You can use that credit to finance further investments, cover renovation costs, or even manage emergency expenses. However, while a HELOC can be a great funding resource in many situations, not all property owners qualify. So how do you know if you’re eligible? And can you get a HELOC on an investment property? Here’s what you need to know.
So, can you get a HELOC on investment property?
The good news is that it is possible to get a HELOC on investment property. The bad news is that, while some banks and credit unions do offer HELOCs to real estate investors, not all do. Further, qualifying for a HELOC for an investment property can be more challenging than qualifying for a primary residence. This is due to several factors:
Eligibility criteria: HELOCs for investment properties tend to have stringent eligibility criteria. They often require borrowers to have high credit scores and good financial stability. In contrast, obtaining a HELOC for a primary residence is typically easier.
Equity: Lenders only offer HELOCs to borrowers who have enough equity in their investment properties — typically at least 20%. For a primary residence, on the other hand, you may only need 15% to qualify for a HELOC.
Interest rates: Interest rates for investment property HELOCs are typically higher than those for primary residence HELOCs. This reflects the perceived risk that many lenders associate with investment properties.
Cash reserves: Many lenders also have stricter requirements for cash reserves when it comes to investment property HELOCs. They often expect borrowers to have an emergency fund equivalent to at least six months of property-related expenses. If you have rental property, you may also need to provide evidence of long-term tenants.
Debt-to-income (DTI) ratio: Your debt-to-income ratio will need to be between 40% and 50% to qualify for most investment property HELOCs. This ratio is often lower for primary residences.
Loan-to-value ratio: The loan-to-value ratio, or LTV ratio, is a financial metric used to assess the risk associated with a mortgage or loan. It represents the ratio of the loan amount to the appraised value of the property. With an investment property, you’ll need a maximum LTV of 80%. For primary residences, the maximum LTV is typically closer to 90%.
Risk assessment and appraisals: When reviewing investment properties, lenders often conduct more thorough risk assessments and property appraisals. This can result in a longer application processing time than you might experience for a primary residence HELOC.
Credit score: When you apply for an investment property HELOC, your lender may require a credit score of 720 or higher. In contrast, for a primary home HELOC, a credit score of 620 or above is typically acceptable.
The pros and cons of getting a HELOC on an investment property
Using a HELOC on an investment property also comes with specific risks, such as variable interest rates and the potential for over-leveraging your equity. Here are a few things to think about before you apply for a HELOC.
Pros
The interest rates on HELOCs are often lower compared to other forms of financing, such as home equity loans and other types of second mortgages.
It may be better to take out a HELOC on an investment property than on a primary residence since you won’t risk losing your home if you default on an investment property HELOC.
During the HELOC draw period, you may be able to make interest-only payments rather than the larger minimum payments required for home equity loans. This may result in more manageable monthly bills.
The interest you pay on your HELOC may be tax-deductible if the funds are used for qualified investment purposes.
You can use HELOC funds for property upgrades or renovations, potentially increasing the property’s value and your future rental income.
A HELOC can be a great way for new property owners to manage cash flow if your initial rental income doesn’t cover all your required expenses.
Cons
Not all lenders offer HELOCs on investment properties, and the limited availability can make it challenging to find suitable options.
You might pay higher interest rates than you would for a HELOC on a primary residence.
Most HELOCs come with annual fees as well as early cancellation or termination fees.
Tenant turnover, unexpected property maintenance expenses, and market dynamics could affect your ability to repay your HELOC, which could lead to increased financial stress.
Lenders may impose stricter eligibility criteria for investment property HELOCs. They may require you to have significant equity in the property, a high credit score, and a low loan-to-value ratio. That can make it more difficult to qualify.
Alternatives to a HELOC on an investment property
If you decide not to pursue a HELOC for your investment property, consider these alternative loan options.
HELOC on your primary home
Homebuyers in need of fast cash may want to consider a primary home HELOC instead of an investment property HELOC. Because lenders often view primary residences as less risky collateral than investment properties, HELOCs on primary residences usually come with lower interest rates. This can result in lower borrowing costs.
Additional benefits include:
Higher equity position: Most borrowers have higher equity in their primary residences than on their investment properties. Maybe you made a substantial down payment, have years of mortgage payments under your belt, or have worked to increase your home’s value. This can result in a higher equity position and therefore a higher HELOC credit limit.
Easier qualification: Lenders often demand fewer personal finance qualification requirements for primary residence HELOCs, which makes them easier to obtain.
Additional services: Some lenders may offer additional benefits or services to homeowners with primary residence HELOCs, such as financial planning assistance or existing-relationship discounts.
Remember that, while a primary residence HELOC offers some advantages, it also involves using your primary home as collateral. Similar to a primary home loan, you’ll risk foreclosure on your home if you fail to make your payments. So, before you sign up for a HELOC, carefully consider your ability to meet your repayment obligations.
Cash-out refinance
A cash-out refinance is a type of mortgage refinancing where you borrow more than what you currently owe on your mortgage and receive the difference in cash. Essentially, it allows you to tap into the equity you have built in your property and use it for other expenses or investments. The new mortgage loan replaces the old one and has a higher balance, reflecting the amount of cash you receive.
Here's how it works in general:
You apply for a cash-out refinance with a lender of your choice.
The lender evaluates your eligibility based on factors such as credit score, loan-to-value ratio, income, and debt-to-income ratio.
If approved, you receive the cash difference between the new amount borrowed and your old mortgage balance.
You can use the cash for various purposes such as home improvements, debt consolidation, education, or investments.
It's important to note that a cash-out refinance typically comes with closing costs, which can range from 2% to 5% of the total loan amount. Additionally, it can lead to higher monthly loan payments and a longer repayment period than your original mortgage.
Personal loan
An unsecured personal loan is a type of loan that doesn't require any collateral. Secured loans (including HELOCs) are backed by assets like a house or car, which can be repossessed by the lender if the borrower defaults. Unsecured personal loans, on the other hand, are approved based on the borrower's creditworthiness and ability to repay the loan.
Here are some key points about unsecured personal loans:
No collateral: Unsecured personal loans are not tied to any specific asset. This means that borrowers don't need to pledge their property or possessions as collateral.
Based on creditworthiness: Lenders evaluate the borrower's credit history, income, employment stability, and other factors to determine their creditworthiness and the terms of the loan, such as interest rate and loan amount.
Higher rates: Since unsecured personal loans are riskier for lenders than secured loans, they generally come with higher interest rates to compensate for the lack of collateral.
Flexible use of funds: Borrowers can typically use the funds from an unsecured personal loan for any purpose, including consolidating debt, financing home improvements, or covering medical expenses.
Lower loan amounts: Compared to secured loans, unsecured personal loans usually come with lower loan amounts, as lenders may be more cautious about granting larger sums without collateral.
Keep in mind that, because you have no collateral securing the loan, defaulting on an unsecured personal loan could result in legal action, damage to your credit score, and collection efforts by the lender.
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A HELOC is a great real estate investing tool and a good way to tap into your property’s equity to get a large cash injection. This can be useful for managing business cash flow or for meeting surprise expenses. However, HELOCs aren’t the best choice for every property owner. If you’re looking for alternative funding options, consider a personal loan. Personal loans can provide swift access to large lump sums of cash. They also tend to offer lower interest rates than credit cards or open lines of credit.
A personal loan marketplace can give you a better idea of your options and help ensure that you’re getting the best rates. To further streamline the process, Navient Marketplace collaborates with Fiona, a leading personal loan search tool. Explore your options and find personalized loan rates by visiting our marketplace today.