How to use HELOC on an investment property?
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You can get a HELOC on an investment property — a house you don’t live in at all — but it can be harder to find, more expensive, and smaller than a HELOC on your primary residence.
Despite these drawbacks, you may want to take out a HELOC against your investment property instead of putting your own home as collateral. This will reduce the risk of losing your home if you are in financial difficulty.
Additionally, owning an investment property is similar to running a business. From a tax and accounting perspective, it’s generally a good idea to completely separate your personal income and expenses from your investment property income and expenses.
Here’s what you need to know about using a HELOC on an investment property:
What is a HELOC?
A home equity line of credit (HELOC) allows you to borrow against the market value of your home, up to a certain limit. You can borrow as much or as little of this limit as you need and pay interest only on what you borrow.
The interest rate is variable and based on an index, such as the Wall Street Journal prime rate, plus a margin determined by the lender. Some HELOCs have a fixed rate option similar to a home equity loan.
As you repay what you borrow, you replenish your line of credit, like a credit card. You can use the money for any purpose.
Learn more: Use a home equity loan or HELOC to pay off your mortgage
Can I use a HELOC on an investment property?
Yes, you can take out a HELOC on an investment property. If you use the money wisely, it can help you build your wealth.
Owning an investment property is like owning a business. You owe taxes on the rental income generated by your property, and you deduct expenses (such as depreciation, interest, and repairs) associated with earning that income. You also capitalize expenses to improve your property, which means you add them to your property’s base cost (or original value).
If you purchase a HELOC on your investment property, you can deduct the interest you pay on your investment property from the income you earn on your investment property – as long as you use the HELOC for expenses related to your placement.
Compared to other forms of borrowing, a HELOC can be an inexpensive way to improve your return on investment – to create leverage, in other words.
Credible does not offer HELOC, but we can help you find a great rate for a cash-out refinance.
Related: Home equity loan or HELOC or reverse mortgage: how to choose
Where to get a HELOC on an investment property
You may have to search harder to find a lender that offers HELOCs on investment properties than if you were looking for a HELOC on your primary residence. Here’s where to look:
- Traditional banks: These are the big banks that offer home loans in multiple states or nationwide, such as Bank of America and US Bank. Some traditional banks (including Chase and Citibank) do not offer HELOC as of October 2022.
- Local banks and credit unions: Local banks or community banks serve residents of a certain geographical area. Credit unions are open to anyone who meets the membership requirements. Some (like Pentagon Federal Credit Union) are open to almost anyone, while others have tighter restrictions.
- Loan brokers: These are individuals or businesses who can match borrowers with loans from various lenders for free.
- Online lenders: These are lenders that do not have a physical location and operate strictly online.
Get a home loan: Compare today’s top lenders
Requirements for obtaining a HELOC
These are the factors that lenders will consider when evaluating your HELOC application. The factors are the same whether you get a HELOC on a primary residence or an investment property, but the requirements will be stricter on an investment property.
Combined loan-to-value ratio
The combined loan-to-value ratio (CLTV) is a way to measure the equity in your investment property. You are more likely to qualify for a HELOC with a lower CLTV.
You can calculate your CLTV by adding the credit limit you are applying for to your existing mortgage balance and dividing that amount by the appraised value of your home.
Debt to income ratio
Calculate your debt-to-income ratio (DTI) by dividing your total monthly debts by your monthly gross income. The lower your DTI, the better.
If you have too much debt relative to your income, lenders may not be willing to offer you a HELOC.
Your credit score is based on information in your credit report, such as the number of loans and credit cards you have and how often you pay your monthly debts on time. This score helps a lender assess the likelihood that you will repay your debts. The higher your credit score, the better.
Some lenders may require you to have a certain amount of money in your savings account or checking account before granting you a HELOC. These reserves act as a safety net that could help you stay current on HELOC payments if your income drops or your expenses increase.
See: Do you have bad credit and want a home equity loan? Here’s what to do
Benefits of using a HELOC for an investment property
Here’s how getting a HELOC for your investment property can help:
- Fund operating expenses and improvements: A HELOC can be an inexpensive way to borrow only what you need to manage and repair your investment property. Ideally, your rental income will cover all of your operating expenses while leaving you with a profit. But if you work with a tight margin, a HELOC can help you during the months when you don’t have tenants.
- Reduce income tax: As we mentioned earlier, you can deduct the interest you pay on your HELOC from the income generated by your investment property. To deduct interest, you must use your HELOC to pay for expenses related to your investment property (not to go on vacation or pay off personal debt).
- Consolidate debt: If you’ve financed improvements to your investment property with a high-interest loan, personal loan, or credit card, you could save money in the short term by opening a HELOC and using it to pay off those balances. .
Related: Refinancing a 15-year mortgage: is it wise?
Disadvantages of Using a HELOC for an Investment Property
Here are some of the less attractive aspects of taking out a HELOC on your investment property:
- Higher interest rate: Lenders generally charge higher interest rates on loans secured by investment properties. They know that if money is tight, a borrower will prioritize payments on their primary residence and other essentials over payments on their investment property. The loss of an investment property due to foreclosure will not disrupt a borrower’s life as much as the loss of their principal residence.
- Lower CLTV: You can borrow up to 100% of the value of your principal residence, but only 70% of the value of your investment property. CLTV requirements vary by lender, but in general, because lending on investment property is riskier, you won’t be able to borrow as much.
- Lower borrowing limit: You may be able to borrow up to $500,000 against a principal residence, but only $100,000 against an investment property. Again, limits vary between lenders and some may be more comfortable than others offering larger HELOCs on investment properties.
Alternatives to HELOCs for investment properties
If you can’t find a lender who will give you a HELOC on your investment property or with the terms you want, here are other ways to borrow:
HELOC main residence
Instead, take a HELOC against your primary property. It might be cheaper and you might be able to borrow more. That said, you will increase your risk of losing your place of sleep at night if you cannot repay the loan.
Refinancing by collection
A cash mortgage refinance on your investment property (or primary residence) could give you a cash lump sum with a fixed interest rate. However, closing costs are usually much higher than with a HELOC, and it’s only a good choice when you can lower your interest rate.
The interest rate on a personal loan may be lower than some credit card rates, and the loan will have a fixed interest rate, monthly payment, and term.
The plus: you won’t have to pledge your principal residence or your apartment building. However, if you default, the lender could sue you and you may have to sell your property to pay the judgment.
A credit card is also based on your personal credit history and does not require any collateral. Instead of a lump sum, it gives you an on-demand line of credit to borrow against, and you’ll only pay interest on what you borrow. Plus, you can often get instant approval.
Credit cards, however, generally have higher interest rates. Late payment can put you further into debt. And, like a personal loan, even if the debt is unsecured, the creditor could sue you if you don’t pay what you owe. You may need to sell your assets to pay them off.
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