Key takeaways
You can get home equity loans on investment and rental properties, though they may be harder to obtain.
To get this type of loan, you'll usually need a stronger-than-average financial profile and substantial assets.
A rental or investment property home equity loan could come with tax benefits, depending on how you use it.
A home equity loan allows you to tap the equity in a property to obtain a one-time lump sum you can use for any purpose. Most homeowners take out these loans on their primary residences. But can you get a home equity loan on an investment or rental property?
If you have sufficient equity in it -- potentially, yes. That said, the process can be more challenging, and you could end up with a higher interest rate and paying some extra expenses to boot.
So, if you're considering a rental or investment property home equity loan, here are a few home truths to consider.
The short answer: Yes, it's possible to get a home equity loan on a rental property.
However, in the eyes of a home equity lender, an investment property can seem like a riskier proposition. This is because you likely don't rely on the rental to serve as the roof over your head, so there's less at stake if you somehow become unable to repay the home equity loan; you're more likely to just walk away and cut your losses (or so the lender figures). In other words, as collateral, rentals don't afford the same peace of mind as a primary residence.
Because of this risk, it might be harder for you to find a lender willing to tie a home equity loan to an investment property or a rental. If you do find one, you'll likely pay more in interest to compensate for that risk.
The requirements for home equity loans for investment properties and rentals vary by lender. But they tend to be tougher than those on loans securitized by residences. Basically, you're getting into business-loan territory. In general, you can expect to need:
Minimum credit score: 700 or higher
Maximum debt-to-income (DTI) ratio: 43 percent (sometimes up to 50 percent)
Maximum loan-to-value (LTV) ratio: 75 percent
Reserves: six months' to 15 months' worth of home equity loan payments
Lenders may also look at the property's income-generating record. If it has a history of a steady, positive cash flow and high occupancy, that's a plus. In contrast, if it's had multiple vacancies and no income within a short time period, that can be a potential red flag for lenders.
Can you get a home equity loan on a rental or other investment property? Maybe. But should you? That depends.
Aside from the risk the lender takes on, you'll be taking on some risk, as well. Similar to a mortgage, when you borrow against a home's equity, you could lose the property if you fail to keep up with payments. In addition, if the property's value decreases, you could find yourself underwater on the loan. This makes it much harder to offload the building if you decide or need to sell.
"If a recession starts, you run the risk of taking out more [in equity] than the property is worth, and you might have a very difficult time selling it," says Dick Lepre, a Pleasant Hill, Calif-based veteran loan advisor with CrossCountry Mortgage. "If interest rates are high, that depresses property values."
Deciding between a home equity line of credit (HELOC) and a home equity loan for tapping equity on an investment property depends on various factors, including your financial goals, risk tolerance, and specific circumstances. Here's a comparison of the two products in a nutshell:
Flexibility: HELOCs offer a revolving line of credit, allowing you to borrow funds as needed, up to a certain limit, and repay them over time.
Variable Interest Rates: HELOCs usually come with variable interest rates, which change with market conditions. This means your monthly payments may fluctuate.
Interest-Only Payments: During the draw period (typically 5-10 years), you may only need to pay back interest payments, followed by principal and interest payments during the repayment period.
Risk: HELOCs can be riskier due to potential interest rate hikes, which could increase your monthly payments.
Lump Sum Payout: With a home equity loan, you receive a lump sum upfront, which you repay over a fixed term at a fixed rate.
Predictable Payments: Since home equity loans have fixed interest rates and repayment terms, your monthly payments remain consistent throughout the loan term.
Risk: Home equity loans' interest rates are lower than HELOCs'. But if interest rates decline in general, you are stuck with a higher rate over a long term.
Consider the following factors when choosing between a HELOC and a home equity loan for tapping equity on an investment property:
How do you plan to use the funds? If you need ongoing access to funds for various expenses or long-term projects -- as you might with a multi-unit property -- a HELOC may be more suitable. If you have a specific expense or project in mind, a home equity loan might be preferable.
What are predictions for interest rates? If you anticipate interest rates to rise, a fixed-rate home equity loan may provide more stability. If rates are low or poised to fall, a HELOC with its variable rates might be attractive.
How much risk are you willing to tolerate? If you're comfortable with potential interest rate fluctuations, a HELOC could be a better fit. If you prioritize predictability and want fixed monthly payments, a home equity loan may be more suitable. Consider how reliable the income from your property is (assuming you'll be using it to pay the debt) -- could it cover a big jump in repayments?
What are your long-term financial goals? If you're investing in the property to eventually sell it, the HELOC might be preferable as it keeps your cash flow fairly free. Bear in mind that both HELOCs and home equity loans must be paid back in full when a property changes ownership.
You can use the proceeds from a home equity loan however you want. That includes repairing or remodeling the property used to secure the loan. It also includes buying another rental or investment property.
You could use the loan proceeds to cover just a down payment, assuming you could qualify for another mortgage. But with your home equity loan in the mix -- and particularly because lenders will consider your overall debt-to-income ratio -- this strategy might be tricky.
Generally, using a home equity loan to buy another property works best when the money's being used for a cash offer. Maybe the proceeds from your home equity loan or HELOC will be enough to cover the purchase price, or maybe they'll augment other assets (investments, savings), just helping you get to the number you need.
Even so, proceed with caution. As you already know from your first rental/investment property, real estate isn't without its risks, appreciation-wise. If the local market shows signs of slowing, now might not be the best time to take on additional real estate-related debt.
Make sure you'd be in a good financial situation, even with multiple rental and investment properties -- plus your home equity loan -- to manage.
There could be, depending on how you use the money you get from your rental or investment property home equity loan.
You can take the funds for any purpose, but one of the most common uses of home equity loans is for renovations -- and for a good reason: Under current tax law, it's the only way to deduct the interest on the debt. Specifically, you must use the loan money to "buy, build or substantially improve" the property backing the debt (your investment or rental property in this case): repairs, upgrades or purchase of adjacent land or lot. And you'll need to itemize your deductions -- which means more work for you or your accountant -- to realize the benefit.
Also, be advised that there are caps on how much you can claim with this deduction.
Joint and single filers who took out their home equity loan after Dec. 15, 2017, can deduct interest on up to $750,000 worth of qualified loans, while separate filers can deduct the interest on up to $375,000. Note these thresholds apply collectively to all home-secured debt -- meaning that if a married couple had a first mortgage and home equity loan on their main home, then took out another home equity loan on their rental vacation home, all three of these obligations together would count towards the $750,000.
There are other ways to fund a rental property. You could consider a cash-out refinance if you have enough equity in your primary residence. You could also consider an unsecured personal loan to help you purchase a rental property.
Cash-out refinancing means you pay off your primary mortgage with a new, larger one and then take the difference between the two mortgages in cash. The amount of money you can access will depend on your home's current value and the equity built up in your home.
You can use the funds of a cash-out refinance for anything, from paying for college to purchasing a rental or investment property. You may be able to secure a lower interest rate or renegotiate the terms of your mortgage. The downside? Your new mortgage payment will likely be more expensive (since the loan's for a larger amount), and you will have less equity in your home.
In addition, a mortgage uses your home as collateral, so if you turn your equity into cash to buy an additional property, you risk losing your primary home if you default on your mortgage.
If you don't have enough equity in your home to use it, consider a personal loan. While you may not be able to secure enough cash to buy a house outright, it may be enough for a sizable downpayment. If you qualify, you might be able to borrow as much as $100,000 from a credit union, bank or an online lender.
Of course, you will have to make monthly payments with interest, but if you are able to buy a rental property and earn passive income on it, you may be able to pay back the loan with your earnings from the rental. These types of loans do not require collateral but to get the best interest rates, you will need excellent credit (a credit score of at least 750). In addition, the lender may look at your income and assets. Your debt-to-income (DTI) ratio should be below 36 percent -- the lower, the better.
Can you use a home equity loan to cover expenses on a rental?Yes, you can use a home equity loan to cover some or all of your expenses on a rental property. However, home equity loans are most useful for one-time costs, not necessarily the ongoing upkeep of an investment property. For this reason, it might make more sense to take out a revolving home equity line of credit (HELOC), either via the equity in your primary residence or the rental home itself, to pay for these expenses -- as you can withdraw funds as needed to cover them.
Is it better to use a HELOC or home equity loan to invest in real estate?It largely depends on your real estate investing strategy. A HELOC generally offers more flexibility than a home equity loan because it's a revolving line of credit, and you don't have to pay interest on funds you don't use. With a home equity loan, you'll need to repay the entire amount you borrowed plus interest, regardless of whether you use it all. Also, you typically only need to pay interest during the HELOC draw period, which helps free up cash flow for other needs.
Can I use a home equity loan to invest in a REIT?Yes, you can use the proceeds from a home equity loan to invest in a real estate investment trust (REIT). But be careful: Going into debt to make an investment can be a slippery slope. Ultimately, a home equity loan is a second mortgage, so you don't want to overleverage your finances without having a clear sense of the return you'll get from the borrowed funds.
Additional reporting by Emma Woodward
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