A HELOC on an investment property allows you to use the equity you’ve built up in a rental property and access those funds through a revolving line of credit, rather than having to apply for a completely new loan.
What is a HELOC on an investment property?
A HELOC on an investment property works much like a HELOC on a primary residence. It provides you with a revolving line of credit secured by a second mortgage on a rental property that you already own. However, because the property is not your primary residence, lenders typically have stricter standards for evaluating the loan.
During the drawdown period, you can borrow from the line of credit as needed and only pay interest on the amount you actually use. After the drawdown period ends, the loan enters the repayment period, at which point you begin making payments on both principal and interest on the outstanding balance. Investors often use this type of financing to fund a down payment on another rental property, pay for renovations, or provide short-term capital between real estate transactions.
Where are HELOCs available for investment property?
HELOCs are available for far fewer rental properties than HELOCs for primary residences. Currently, only a limited number of states have lenders that offer a full range of HELOC options for investment properties. As a result, the location of the property can determine whether you can get this type of financing at all.
Even if a rental property is located in a state where HELOCs are not available for investment properties, the same lender may offer other options, such as a home equity loan or DSCR cash back. Before you base your financing strategy on a HELOC, make sure the program is available in the state where your property is located.
HELOC vs. Home Equity Loan for an Investment Property
A HELOC gives you a revolving line of credit that you can draw on multiple times over the life of the loan. Its interest rate is variable, linked to an index, and can change periodically. In contrast, a home equity loan gives you a lump sum at the beginning of the loan and has a fixed interest rate and a fixed repayment schedule from the start.
A HELOC can be more suitable for investors who want access to capital on an ongoing basis; for example, investors who are financing the renovation of multiple properties or who want to have a line of credit available for a future investment. A home equity loan can make more sense when you know exactly how much money you need in advance, such as when you need funding for a specific renovation or a predetermined down payment.
For a detailed comparison of the costs, flexibility, and repayment terms of each option, see HELOC vs. Home Equity Loan.
Requirements for a HELOC on an Investment Property
Lenders typically consider several factors when considering a HELOC for an investment property:
- Significant net worth in the rental property: HELOCs for investment properties typically have lower CLTV limits than HELOCs for primary residences, so you may need more net worth.
- Strong credit score: Lenders often require a higher credit score than for an owner-occupied property HELOC, as a second mortgage on a non-owner-occupied property is riskier.
- Documented rental income and/or adequate DTI: Lenders must take into account the fact that the property is an investment and not your primary residence.
- Cash reserves: You may need to keep reserves separate from the net worth you are borrowing from; these reserves should often be sufficient to cover several months of payments on your mortgaged property.
- Good mortgage payment history: Regular and on-time payments on your existing mortgage are important, as a HELOC is a second mortgage and is dependent on the first mortgage remaining current.
Documents You Will Typically Need
When applying for a HELOC on an investment property, you will typically need to provide a current mortgage statement, a recent property appraisal or other appraisal used by the lender, and evidence of rental income from the property. For a multi-unit property, this could include a lease or rental report. Depending on how the lender evaluates your application, you may also need proof of personal income, bank statements, and proof of assets to verify cash reserves.
If the property is owned through an LLC, additional documentation of the business entity may be required. Some lenders also limit their HELOC programs to properties owned by individuals, not legal entities. If your rental property is held under an LLC, verify the lender’s ownership requirements before applying.
HELOC Rates for Investment Property
HELOCs secured by investment property typically have higher rates than HELOCs secured by a primary residence. The rate is also variable, so your monthly payment can increase or decrease over the life of the line of credit as the underlying index changes.
There is no single rate for all HELOCs secured by investment property. Pricing can change frequently and depends on factors such as the lender, your credit standing, the location of the property, and the size of the line of credit compared to the value of the property. Instead of relying on a general rate estimate, ask each lender for the current APR and, if available, historical rates so you can compare your options.
The tax treatment of an investment property HELOC differs from a primary residence HELOC
Interest paid on a HELOC secured by an investment property is generally considered an expense related to rental activity, not under the mortgage interest deduction rules that apply to a primary residence.
However, how this interest is deducted depends on your individual tax situation and how you use the borrowed funds. For this reason, it is best to consult a tax professional rather than assuming that an investment property HELOC will have the same tax treatment as your primary residence HELOC.
Alternative: DSCR Cash Repayment
If a HELOC is not available for investment property in your state, you prefer a fixed rate to a variable rate, or you want to replace your current mortgage rather than add a second mortgage, DSCR Cash Repayment could be an alternative.
With a DSCR Cash Repayment, you access the equity in your rental property by paying off your existing mortgage and receiving the cash. Eligibility is based primarily on the property’s rental income, not adding a second mortgage through a HELOC. In contrast, you lose the flexibility of a revolving line of credit and instead have a new, single loan balance with a fixed rate structure.
DSCR Cash Repayment can also be an option in states where HELOCs are not available for investment property, as these programs typically have broader coverage from lenders. This option may be more suitable if you want to take a large, fixed amount of the property’s equity in one transaction and don’t need frequent access to the funds afterward.
In comparison, a HELOC is usually more practical when you want a continuous line of credit that you can draw from multiple times. For a direct comparison of the two options, see Cash Advance vs. HELOC.
Using HELOC Equity to Expand Your Investment Portfolio
Investors can use the equity in an existing rental property to help fund the purchase of another investment property. Instead of saving up a whole new down payment, they can take out a HELOC and apply some of the equity they have already built up in their portfolio of properties.
For example, an investor might use the equity in an older, well-performing rental property to help cover the down payment on a new property. As the equity in the new property increases over time, this equity can also potentially become another source of funding for future investments.
This strategy works best when the initial property has significant equity and the investor’s overall investment property financing situation can easily cover the additional payment. This includes having a manageable debt-to-income ratio and sufficient reserves on all available properties, rather than relying solely on the net worth you’re borrowing against.
Risks to Consider Before Getting a HELOC
Because HELOCs have variable interest rates, your monthly payment can increase during both the down payment and the repayment period. Because a HELOC is a second lien, the increased monthly payment adds another cost to the property’s cash flow, even when the rental property is currently performing well. If rental income declines or a unit becomes vacant, you’ll still have to make the HELOC payment.
