While there are some challenges that may come with securing a home equity line of credit (HELOC), the benefits are often worth the investment of time and resources. Using a HELOC on investment property will allow investors to tap into assets that have managed to build up equity. Likewise, investors can take advantage of otherwise stagnant equity. It can be thought of as an alternative funding source to do any number of things: upgrade your home, boost your credit, consolidate debt, or even buy a new property. At the very least, understanding how to use a HELOC on an investment property is crucial for anyone who wants to gain a competitive edge.
What Is A Home Equity Line Of Credit (HELOC)?
A home equity line of credit is a homeowner loan with a maximum draw, as opposed to a fixed dollar amount, that is backed by the lendee’s equity in their home (similar to a second mortgage). A HELOC is a lender’s promise to advance the lendee up to the set amount at the time of their choosing, as opposed to a regular mortgage which is typically paid out in full at closing.
Most HELOCs have set “draw” periods where the borrower must use the credit and then another period where they must repay the loan. Borrowers are typically given five to 10 years where they are required to only pay interest while repayment periods are typically 10 to 20 years.
[ Need money to invest in real estate? Use this 7-Figure Fundraising Kit to get the capital you need ]
How Do You Use A HELOC On Rental Property
A HELOC can become an invaluable source of alternative financing as soon as investors build up enough equity in an asset. When managed correctly, a rental property HELOC can even turn into an ideal wealth-building strategy for savvy investors.
For one, investors can borrow money against the equity in one rental property to fund the purchase of another. Additionally, investors can use a HELOC to fund home improvements for their rental properties, just as a homeowner would for their primary residence. Investors can also use HELOCs to pay off other high-interest debt if necessary. Smart investors will even get a HELOC on their primary residences to pay off mortgages on their investment properties.
Because rental property mortgages generally carry a higher interest rate, smart investors can get a HELOC on their primary residences to pay off the mortgages on their investment properties.
There are several challenges investors must overcome in order to successfully use a HELOC on rental properties. For starters, banks are less inclined to lend on investment properties, as owners are more likely to default on homes that aren’t a primary residence. The incentive to stay current on a primary home is less apparent in investors with rental properties. It may also be difficult for investors to even qualify for a HELOC. Lenders look at debt-to-income ratio, credit score, other open accounts, and lendee’s available cash cushion. Even if you have available cash flow, it doesn’t necessarily make you the right candidate.
It may be easier and more likely to qualify for a line of credit on a primary residence, investors (and homeowners) can experience great benefits if they do choose to pursue the HELOC route.
Can You Use A HELOC For A Down Payment On An Investment Property?
A HELOC can be used to buy an investment property. In fact, if you are going to use a HELOC on anything, you might as well put it into a sound investment. Unleveraged equity is, after all, dead money that could end up costing you in the long run. Thanks largely, in part, to inflation, stagnant equity that isn’t making any interest or return on investment (ROI) is essentially throwing money away. That said, using equity to buy an investment property with a sound gameplay is almost always preferred to using equity for anything else. Since a HELOC will use the home as collateral, it’s important to make sure the loan is worthwhile.
Home Equity Loan Vs HELOC
Home equity loans offer borrowers a lump sum of capital that the bank will expect to be repaid over a predetermined period of time. A HELOC is a revolving line of credit that can be tapped into whenever the borrower likes.
At a glance, home equity loans (HELs) and HELOCs appear to have a lot in common. The similarities in their names alone are enough to confuse anyone who is unfamiliar with their uses. It is worth noting, however, that their similarities are only “skin deep.” There are several differences between HELs and HELOCs investors need to know about before they acquire one over the other.
For starters, the interest rates on each are different. Traditional home equity loans tend to have a fixed-interest rate. HELOCs, on the other hand, usually have variable rates, which can drastically impact the amount owed over a long period of time. In addition to how interest rates are accounted for, the manner in which each is paid is also different. While there are exceptions, home equity loans tend to follow a more structured payment plan. Simply put, HELs are usually paid back with a monthly fixed amount; accounting for both principle and interest payments with each installment. Subsequently, HELOC payments will be determined by the amount the homeowner borrowers against their home and are subject to shifts in interest rates.
Is HELOC On Rental Property Tax Deductible?
In the event the loan is secured by the respective rental property, the mortgage interest becomes a rental expense, which can then be used to reduce your taxable income.
How To Qualify For An Investment Property HELOC
In order to qualify for a HELOC, borrowers must meet three specific requirements:
Know Your Credit Score
Not unlike just about every source of capital, lenders will pay special considerations to one’s credit score. After all, banks will use credit score to determine whether or not a borrower is a risk. Therefore, the better the credit score, the more likely someone is to qualify for a HELOC. It should be noted, however, that there isn’t a universal standard for an acceptable credit score; different lenders have different criteria. What one lender may consider a ‘good score,’ another may consider poor, or even risky perhaps. Traditionally, borrowers will want to boast a credit score of at least 740 if they want to tip the scales in their favor, but again, everyone is different.
Know Your Debt-To-Income Ratio
Along with a good credit score, borrowers will want to prove that taking out another loan won’t upset the balance they currently have between income and debt. In doing so, banks will calculate your debt-to-income ratio to see if you can afford to borrow more, in addition to what you already owe. Unlike credit scores, however, lenders have set a precise debt-to-income ratio minimum: somewhere between 40% and 50%.
The single most important factor someone needs to qualify for a HELOC is equity. To be clear, a house has equity if the balance on the remaining mortgage is less than the house is worth. Therefore, any borrower with equity in their home has already met the first criteria for qualification.
Top 5 Benefits Of Using A HELOC For Investment Property
When it comes to financial stability, both homeowners and investors should be prepared with a plan. Using the equity in a home or investment property to pay for home upgrades or to cover unexpected expenses (in the form of a HELOC) can be a great option for those who are financially healthy. Keep reading to discover more ways to use your home as a valuable tool.
Finance Home Improvements: One of the most common ways both homeowners and investors use HELOCs is to finance home improvement projects. In fact, the interest you pay on a home equity loan is usually only tax deductible of use use the money for home-related projects (i.e. not for the purchase of a new car or vacation ticket). If you are a homeowner in a position to pay down a loan quickly, using a HELOC is a great option. However, if you believe it might take you longer the five years to pay down the loan, a refinance or cash-out refinance might be your best bet if you can secure a lower, fixed-rate interest.
Consolidate Debt: One of the best ways to consolidate credit card debt, other debt, or cover the finances that accompany a family emergency is by using your home’s equity. If unexpected expenses arise and you don’t have an emergency fund in place, using a HELOC is an effective way to access capital fast. The interest may not be a tax deductible (if you are using a HELOC to pay for, let’s say, medical expenses) but HELOCs still typically come with lower interest rates than other debt consolidation vehicles. Paying this interest will also likely be cheaper than incurring capital gains that come with selling other investments, especially if you know you only need the funds for a short period of time.
Move With Ease: If you are a homeowner who is planning to move but you still need a little extra capital to fund your new down payment (or other moving expenses), using the equity of your current home as a financial tool can be a smart move. Note however, that you typically won’t qualify for a HELOC if your home is already on the market; so be sure to plan ahead.
Dip Into Savings: Fun fact: most Americans carry the bulk of their savings in retirement accounts and plans like 401(k)s. However, withdraws from these accounts before the age of 59 ½ are subject to income taxes and possible penalties. This means, if you’re a homeowner or investor who needs to withdraw money for short-term expenses early, you’re not getting the biggest bang for your buck. So if you need additional capital before you retire, tapping into your HELOC can be helpful.
Boost Credit: When a lender approves your HELOC application and you begin to make payments on the loan, the account will appear on your credit report. And guess what is the number one factor that affects your credit score…that’s right — your payment history with creditors. Once you begin to make consistent payments, it is likely your score will improve. Additionally, your credit rating will improve if you use less than 30 percent of your line of credit spending limit.
Alternatives To HELOCs
While there are numerous benefits that come with using a HELOC on your home or investment property, there are alternatives to HELOCs that are still desirable. The following are a few examples:
Home Equity Loan: The only slight difference between a HELOC and a home equity loan is the way borrowers are able to access their lines of credit. HELOCS have an open-ended line of credit similar to a credit card while a home equity loan is typically set.
Cash Out Refinance: If you are unable to use a HELOC, which is essentially a second mortgage, consider refinancing your first mortgage. When you take out a new loan that is bigger than your existing one, there is typically cash left over for you to use however you wish (hence the name, “cash-out” refinance). If you can get a lower interest rate, this strategy is a great alternative to HELOCs.
Personal Loan: When most people think about personal loans, they typically think about borrowing a few thousand dollars, but there are some personal loans that let individuals borrow up to $35,000. Personal loans come with lower set-up costs than HELOCs and refinances, so if you need a little extra cash for just a short period of time, you’re in luck. Keep in mind however, that these loans typically come with higher interest rates as the loan is not backed by an asset.
Using a HELOC on investment property can be a great way to tap into alternative sources of financing. After all, the more ways investors know how to fund a deal, the better off they will be. At the very least, having access to working capital is a great way to increase your bottomline if the money is invested wisely.
Have you had experience using a home equity line of credit for your investment property or primary residence? Share your stories in the comments below.
The post Using A HELOC For Rental Properties Made Simple appeared first on FortuneBuilders.