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Should You Consider A HELOC On Your Investment Property?

Jamie Johnson5-minute read

April 12, 2021

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If you’re looking to finance a large purchase, you’ve probably been considering the best type of loan to take out. But did you know that you can tap into the equity you’ve already built up in your investment property?

This type of lending product is called a home equity line of credit (HELOC). It’s an option for anyone who needs an ongoing line of credit but doesn’t want to rely on a credit card or the high interest rates that come with it.

But there are downsides to this strategy, so you want to make sure you go about it the right way. This article will explain how to take out a HELOC on an investment property, as well as the pros and cons of that decision. It’s important to note that Rocket Mortgage® does not offer HELOCs.

First, What Is A HELOC?

If you need to borrow money to cover a financial emergency or finance a one-time purchase, there are two primary ways you can go about this. You can take out a personal loan and receive a one-time lump-sum payout.

Or you can take out a line of credit, where you’re allowed to borrow up to a maximum loan amount, and you can take the money as you need it. This flexibility can help anyone who doesn’t know exactly how much money they’ll need to borrow.

A HELOC is a revolving line of credit, and once you’re approved, you’ll enter into an initial draw period. During this time, you can withdraw money as needed, and you’ll make minimum payments to cover the cost of interest. The draw period typically lasts 5 – 10 years, though this will depend on your lender.

Once the draw period is over, you’ll enter into the repayment period. During this time, you’ll pay back both the interest and the money owed.

The repayment period typically lasts up to 20 years, though the exact terms will vary depending on your lender and the amount of money borrowed.

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Are HELOCs On Rental Properties Different From HELOCs On Homes?

At this point, you may be wondering how an investment property HELOC differs from a HELOC on a primary residence. And while they are similar in theory, there are a few practical differences you need to know about.

They’re Considered Riskier, So They Cost More

Because the property you’re taking out a HELOC on isn’t your primary residence, it’s seen as riskier than a regular HELOC. Your cash flow is tied up in multiple properties so lenders may see you as a higher risk for defaulting. For that reason, you’ll likely have to pay more in fees and interest.

It’s Harder To Find Lenders

Taking out a HELOC on an investment property is considered much riskier than taking out a HELOC on your primary home. Most lenders prefer to offer lending products where there is a high likelihood the borrower will repay the loan. For that reason, many lenders don’t offer these types of loans, including Rocket Mortgage®.

It’s Tough To Qualify

If you find a reputable lender that offers HELOCs on investment properties, they likely have stringent approval requirements. So, if you’re hoping to secure a HELOC because you’re facing financial difficulties, it’s unlikely that you’ll qualify for a HELOC on your rental property.

Here are the requirements you’ll need to meet to be considered:

  • An excellent credit score (720 or higher)
  • A maximum 80% loan-to-value ratio
  • Healthy cash reserves on hand
  • Sufficient income from tenants
  • Additional features that make the property attractive, like whether it has long-term tenants

Are There Advantages To Taking A HELOC On Investment Property?

There are some advantages to consider before you write off HELOCs as being too expensive or difficult to obtain. As an investor, you want to ensure that your assets are productive. And money tied up in a property’s equity in a rental property is unproductive.

And HELOCs only cost money if you spend the funds. You can always keep the HELOC on hand as a source of cash flow should an investment opportunity arise.

And finally, the draw period for HELOCs usually lasts up to 10 years, so there’s no immediate rush to spend the cash. And you don’t have to begin repaying the line of credit until the draw period is up.

Are There Disadvantages Of Taking A HELOC On Investment Property?

Taking out a HELOC on an investment property won’t be the right choice for everyone. Given the risk and expense involved, it’s worth taking the time to consider whether a HELOC is the right choice for you.

Risks Of Using Investment Property As Security For A Loan

Perhaps the biggest downside of taking out a HELOC is that you’re putting your property at risk. In this instance, you’re not risking your primary residence, but you do risk foreclosing on your rental property. If this happens, you’ll lose your investment and all the future income you could have earned.

High Interest Rates

A HELOC on an investment property typically comes with variable interest rates, which can get expensive very quickly. You need to pay close attention to how much you’re paying back in interest.

Are There Tax Benefits To Using A HELOC On A Rental Property?

The Tax Cuts and Jobs Act of 2017 changed many of the rules for claiming tax deductions on your mortgage. As a result, certain tax benefits may come with taking out a HELOC on an investment property.

When you take out a mortgage on a rental home, you can write off any expenses you incurred as a landlord. And if you take out a HELOC on that mortgage, you can write off a portion of the interest you paid on the loan over the past year.

Are There Alternatives To HELOCS On Rental Properties?

If you’re not sure if taking out a HELOC on a rental property is the right choice for you, there are other options you can consider. Let’s look at three alternatives:

 

  • Cash-out refinance: In a cash-out refinance, you refinance your rental property at a higher loan amount and then receive the difference in cash. The advantage of this is it doesn’t add another monthly payment to your list of bills. Instead, the funds are rolled into your current mortgage. And you can spend the funds however you see fit. 
  • HELOC on your primary residence: Another option is to take out a HELOC on your primary residence. Assuming you meet the requirements, a traditional HELOC is easier to qualify for and usually comes with lower interest rates. However, you will be putting your primary place of residence at risk.
  • Unsecured personal loan: And finally, you can always consider taking out an unsecured personal loan. When you take out a loan, you’ll receive a one-time lump sum payment. The funding is quick, and strong candidates may be able to qualify for low rates. But you will have to start making repayments right away.

How Can I Find A Lender Willing To Offer HELOCs On Investment Properties?

If you want to pursue a HELOC on your investment property, the first step is to find a reputable lender that offers these types of loans. The best way to do this is by speaking to your professional contacts and networking in social media forums geared toward real estate investors.

These individuals may be able to point you toward a trustworthy lender. It’s also a good idea to consult with a trusted financial advisor before applying.

The Bottom Line: A Big Risk That Might Yield A Big Reward If Used Properly

When you take out a HELOC on an investment property, you can utilize the equity in your rental home. This allows you to put that money to work for you, and there may be tax advantages that come with it.

However, the application requirements are pretty strict, and it tends to be more expensive than other types of loans. And many lenders, including Rocket Mortgage®, don’t offer this type of loan. So take the time to learn more about refinancing investment properties first.

Low rates were a big story in 2020. It was a great year to refinance!

Great news about 2021 so far: Rates are still relatively low.

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Jamie Johnson

Jamie Johnson is a Kansas City-based freelance writer who writes about a variety of personal finance topics, including loans, building credit, and paying down debt. She currently writes for clients like the U.S. Chamber of Commerce, Business Insider, and Bankrate.