Obtaining a HELOC for a Rental Property

Here's how to qualify and what to watch out for

You may access the money you've built in your house with a home equity line of credit (HELOC), but did you know you can also get one for investment property? You might be able to use a HELOC to free up some cash if you own a vacation or rental home, for example, so you can make improvements or a significant purchase. While establishing a line of credit on a rental property can be a smart move, there are certain hazards involved. Let's examine what it means to obtain a HELOC on an investment property, how to become eligible, and potential dangers to watch out for.

Key Takeaways

  • An investment property qualifies for a HELOC.
  • HELOCs for investment property often have higher interest rates than those for owner-occupied residences.
  • You can get the best rates on a HELOC by having a high credit score, a low debt-to-income ratio, and lots of cash on hand.

Can You Get a HELOC on an Investment Property?

A home equity loan and a HELOC are the two ways you can access the equity in your house (the portion of your property that you own entirely). You receive a lump sum of money up front and must repay it within a set time frame with a home equity loan. While a HELOC functions similarly to a credit card. Because it is a revolving line of credit, you can use the equity anytime you need to. You can use a check, debit card, or credit card linked to your HELOC to access the money, and you'll only need to make payments on the balance that you actually use. More specifically, there is a period of time known as the "draw" period for these loans where you can withdraw money as needed and make the bare minimum payments to cover the interest costs. Draw periods often last five to ten years, depending on the lender. You enter the repayment period when the draw period is through and repay the loan's principle and accrued interest during this time. Although durations can vary depending on your lender and the amount you borrowed, repayment periods typically last 20 years. The concept of obtaining a HELOC on your residence may be familiar to you. The equity of an investment property, such as a vacation house, rental property, or flip that you intend to fix up and resell for a profit, may also be accessed via a HELOC, depending on the bank. If a lender refers to a property as "non-owner occupied," it simply indicates that it isn't your primary residence. These residences may have stricter loan qualification criteria than owner-occupied properties, sometimes known as your principal residence. Additionally, fewer lenders provide HELOCs for investment property due to the higher default risk associated with these loans.

Getting a HELOC on an Investment Property

There are a few things to think about if you're considering about getting a HELOC on your rental property. Start by researching many different banks and credit unions to find out which are most likely to lend you money based on your position because lenders have varied qualification standards.

Qualifications

Depending on the lender, where you live, and the loan terms, different amounts of equity may be required to qualify. As a general rule, you must have between 20 and 40 percent equity in your investment property to be eligible. The amount you can borrow from a lender may also vary, but keep in mind that once the draw time has ended and the payback term has started, you will be required to reimburse all of the money you have borrowed. Finding a willing lender may take some time because many banks are reluctant to offer HELOCs on investment property. Some banks will accept a minimum credit score of 620 in order to qualify you for a HELOC on your investment property. But the more likely it is that you will be eligible for a reduced interest rate, the higher your credit score. Finally, to be eligible for a HELOC on your investment property, keep your debt-to-income (DTI) ratio low. By dividing your monthly debt payments by your gross monthly income, lenders often determine DTI. The maximum DTI that a lender will permit varies, but generally speaking, the larger your down payment and the higher your credit score, the more probable it is that your lender will permit a higher DTI. Ideally, you should always try to maintain your DTI below 36 percent. A low DTI is typically considered to be below 15 percent.

Interest rates

When taking out a HELOC on a rental property as opposed to your primary residence, be prepared to pay a higher interest rate. This is because lending money for investment properties is riskier in the eyes of banks than lending money for a primary dwelling. The lender views borrowers as having a higher risk of default because their cash flow is frequently entwined with several assets.

Reserve Requirements

Before approving you for a HELOC, banks frequently demand that you have a certain amount of reserves, or liquid funds, on hand. The loan size, your credit score, occupancy, and loan-to-value ratio are some of the variables that affect the reserve minimum. Expect to need between 12 and 24 months' worth of cash on hand to qualify for a HELOC on your investment property, however The Balance has discovered requirements as high as 36 months.

Appraisal Process

Your lender may request an assessment to establish the current value of your property before approving you for a HELOC. Your lender will determine how the appraisal is done; in certain cases, the appraiser may merely need to drive by your property or look up public documents to determine its value.

Tips for Qualifying

Banks evaluate your application for a HELOC using a number of different factors. Some of these factors are somewhat under your control. Make sure your credit score is as high as it can be if you want to be eligible for a HELOC on your investment property. This entails paying your bills on time and minimizing your credit usage (the ratio of your outstanding debt to your available credit). Additionally, you should work to keep your debt-to-income ratio at a healthy level, which is often less than 15%. Whether you're an employee or self-employed, proof of income is typically required in order to qualify. Last but not least, if you own a rental property, be sure you can demonstrate that you receive a suitable amount of revenue from your tenants as well as any other intangibles that might make you a more desirable borrower, such as long-term tenants.

Cons of taking out a HELOC on a rental property

When obtaining a HELOC, use prudence. Your property may be at risk if you make payments late or skip a payment as a result of the rising interest rate. Since you're using your property as collateral, if you end up failing on the loan, you can be forced to sell it or face foreclosure. Also possible are variable interest rates on HELOCs secured by investment properties, which are depending on market rates and can be very expensive.

Pitfalls To Watch Out For

The requirements for HELOCs for investment homes differ among lenders. To be sure you're obtaining the greatest interest rates, shop around with several lenders. Additionally, you must choose whether you want a regular or interest-only HELOC and how long of a draw period you require. Finally, thoroughly read the loan terms to ensure that they apply to your position.

Frequently Asked Questions (FAQs)

Which lending institutions provide HELOCs for rental properties?

HELOCs for rental properties are available from a variety of lenders; to make sure you're getting the best loan for your requirements, check with your bank and other financial institutions.

What is the turnaround time for a HELOC?

The time it takes to obtain a HELOC can differ, but generally speaking, the loan procedure might take up to 45 days or longer.

How much equity must be present in your rental property before you can apply for a HELOC?

Lenders have different requirements, but generally speaking, you may need between 20 and 40 percent equity. You can figure out your equity by deducting your loan balance from the property's current appraised value.

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