Can you buy an investment property with a HELOC?
Quick insights
- Yes, you can use a home equity line of credit (HELOC) to buy an investment property; you do this by borrowing against the equity in your current home.
- A HELOC can help you pay for a down payment, closing costs or renovations.
- Using a HELOC provides flexible access to money, but it also increases debt that puts your home at risk if it isn’t repaid.
Buying an investment property can be expensive, especially when it comes to the down payment and upfront costs. For some homebuyers, a home equity line of credit (HELOC) makes this purchase possible. There are two common scenarios. You might use a HELOC on a rental property you already own. Or, you may use equity from your main home to buy a new property.
Depending on the mortgage lender, the amount of equity you’re allowed to leverage from a property you own can help you finance another real estate purchase. Before moving forward, it’s important to understand how to use a HELOC to buy an investment property, along with its benefits, requirements and risks.
How a HELOC works
A HELOC is a revolving line of credit that lets you borrow against equity you’ve built in a property. There’s a credit limit and a period of time when you can draw funds. During this draw period, you can access money as needed and usually pay interest only on what you borrow. Once the draw period ends, you enter the repayment period, when you pay back the principal and interest. Common HELOC uses include debt management, down payments, closing costs and home improvements.
How do you use a HELOC for an investment property?
To use a HELOC for an investment property, you may draw the necessary funds from your credit line and apply them directly toward the purchase of the new asset—most commonly to cover the upfront costs for an investment property mortgage.
To qualify for a HELOC, lender requirements typically include:
- Sufficient equity: You typically cannot borrow 100% of your property’s value with a HELOC. Lenders may require you to retain at least 20% equity in the home after setting the HELOC limit. The property may need a home appraisal to confirm its market value and condition before a lender approves the HELOC.
- Credit score: Your credit profile, including your credit score, affects HELOC qualification and terms. Lenders want to be confident you will repay the debt in full and on time.
- Debt-to-income ratio (DTI): Lenders want to assess your ability to manage additional debt. Your DTI ratio—including your current mortgage, the projected HELOC payments and other liabilities—should generally remain below 43%.
- Proof of income and reserves: When applying for a HELOC, you provide comprehensive documentation of your income and cash reserves. Lenders generally want to see you can manage multiple property expenses simultaneously.
Scenario 1: Using a HELOC from your primary residence
Leveraging the equity in your primary residence is one potential route for funding an investment property. You might benefit from how lenders evaluate HELOC applications on owner-occupied homes. For instance:
- Borrowing limits: Lenders may extend higher loan-to-value ratios (LTV) on a primary residence. You may be able to borrow up to 80% of your home’s appraised value, minus your outstanding mortgage balance, for example.
- Interest rates: In general, lenders view the risk of default as lower on a primary residence. This could mean the interest rates attached to the HELOC are more competitive.
- Availability: Major banks, credit unions and mortgage lenders offer HELOCs on primary residences. This can give you the leverage to shop around and negotiate terms.
In this scenario, you are putting your own home on the line. Ideally, the return on the investment property will comfortably cover its own mortgage, expenses and HELOC. Whether it’s from rental income or flipping the property, real estate investment carries unique risks.
Scenario 2: Using a HELOC on another rental or investment property
If you already own an investment property that has accumulated equity, you could use a HELOC on that property to fund your next acquisition. However, the lending environment is distinct in this scenario.
Rental properties are a type of investment property where the primary goal is to buy the home and rent it out to tenants to collect monthly income. An investment property is the broader category because it includes rental properties, but also other strategies like:
- Buying a home and selling it later for a profit (house flipping or home appreciation)
- Holding a property long-term while it increases in value
- Operating short-term rentals
Lenders tend to consider non-owner-occupied properties to be higher risk.
How do HELOCs on rental properties differ from HELOCs on a primary home?
Getting a HELOC on a rental property may be more challenging than getting one on a primary residence. Because lenders often view investment properties as higher risk, qualification requirements may be stricter.
This could affect various terms:
- Borrowing limits: Lenders may impose more conservative LTV caps for HELOCs on investment properties, such as 70% to 75%. This generally means you need a substantial amount of equity built up before a HELOC becomes an option.
- Costs: To offset their increased risk, lenders might charge higher interest rates and additional fees compared to a primary residence HELOC.
- Qualification requirements: Lenders may take a detailed look at the cash flow of the existing rental or investment property to ensure it can support the new debt of a HELOC. Lenders may also have higher credit score requirements for investment property HELOCs.
- Availability: Fewer financial institutions offer HELOCs on investment properties. You may need to find certain lenders, such as smaller regional banks or credit unions, that specialize in these specific products.
While some mortgage lenders may not offer HELOCs on investment properties at all, others may limit how many financed properties a borrower can have. The type of property can also affect eligibility. For example, mortgage lender requirements may differ for:
- Single-family rental homes
- Multi-unit properties
- Vacation homes
- Condos or townhomes
In some cases, learning how to get a HELOC on an investment property starts with comparing lender-specific eligibility requirements and property restrictions.
Pros and cons of using a HELOC to buy investment property
Buying property with a HELOC can be attractive to investors for various reasons, including the flexible access to money. However, buying property with a HELOC can also have potential drawbacks.
Pros
- Access to money: A HELOC can fund your down payment, full purchase or home improvements.
- Interest-only payments: You might only have to pay interest during the draw period. This can keep your early payments low.
- Revolving credit: You can borrow, repay and borrow again during the draw period.
Cons
- Collateral risk: Your home secures the HELOC. If you cannot pay, you risk foreclosure and losing your property.
- Variable interest and fees: HELOCs usually have variable rates. This means your monthly payments can go up. You may also have to pay closing costs.
- Increased debt: Using a HELOC adds to your total debt. This can make it harder to get approved for other loans later.
Are HELOCs on investment properties tax deductible?
In some cases, your HELOC interest may be tax deductible. However, this depends on how you use the money and current tax laws. If you use the funds to buy, build or greatly improve the investment property, you might qualify for a deduction. Tax rules for investment properties are different from primary homes. Please consult a tax professional.
Other ways to buy an investment property
A HELOC is one financing option for investment properties, but it’s not the only one. Depending on your financial situation, personal goals and available home equity, there may be other ways to fund a real estate investment purchase.
Home equity loan
A home equity loan allows you to borrow a lump sum against the equity in your home and repay it over time with fixed monthly payments. Unlike a HELOC, which works as a revolving line of credit that borrowers can draw from as needed, a home equity loan provides the funds all at once.
Home equity loans also typically come with fixed interest rates, while HELOCs often have variable rates that can change over time. Because of the predictable payments, some borrowers may prefer a home equity loan for large one-time expenses, such as a down payment or major property renovations.
Cash-out refinance
Cash-out refinances involve refinancing your mortgage for more than you currently owe. Your current mortgage would be replaced, so the monthly payments and loan term would change. Then, you’d receive the difference in cash.
Traditional mortgage
These long-term loans (15-year mortgage to 30-year fixed-rate mortgage) are usually available at fixed or adjustable interest rates. The mortgage options for purchasing investment properties may have stricter requirements to manage the lender’s risk. For example, you may have to put more down on an investment property than you would on a property where you intend to live.
Cash purchases
Some real estate investors choose to buy properties entirely with cash. Paying in cash can simplify the buying process, eliminate monthly mortgage payments and make offers more competitive in certain markets. However, using cash also means tying up a large amount of money in a single investment, which may reduce financial flexibility.
In summary
When leveraging home equity for an investment property, a HELOC may be the right choice for you. There are several ways to draw from a HELOC that can help finance or fully fund an investment home purchase. Common benefits are the flexible access to money and the potential to make interest-only payments during the draw period.
Most of the potential drawbacks and risks are related to real estate market trends. Equity is tied to property value, and that can fluctuate over time. Direct alternatives to funding investments with home equity are home equity loans and cash-out refinances.
