Can You Get a HELOC on an Investment Property?
There are two ways you can tap into your home’s equity (the amount of your property that you own outright): a home equity loan and a HELOC. With a home equity loan, you get a lump sum of cash upfront and pay it back within a specific period. A HELOC, meanwhile, is like a credit card. It’s a revolving line of credit, which means you can tap into or “draw” on the equity whenever you need to. You can access the funds by using a check or debit or credit card associated with your HELOC, and you’ll only be required to make payments on the portion of the balance you actually use. More specifically, these loans typically have what’s called a “draw” period, where you withdraw funds as needed and make minimum payments to cover the interest charges. Depending on the lender, draw periods usually last from five to 10 years. Once the draw period ends, you enter the repayment period, when you pay back both the principal and interest owed on the loan. Repayment periods generally last around 20 years, although terms vary depending on your lender and the amount you borrowed. You may be familiar with the idea of getting a HELOC on the home you live in. Some banks will also allow you to use a HELOC to tap into the equity in an investment property, such as a vacation home, rental property, or flip that you plan to fix up and sell for a profit. The loan qualification requirements for these types of homes may be more stringent than those for an owner-occupied property, aka, your primary residence. And fewer lenders offer investment property HELOCs due to the potential default risk, which tends to be higher on these loans.
Getting a HELOC on an Investment Property
If you’re thinking about getting a HELOC on your investment property, there are several aspects you’ll need to consider. Lenders have varying qualification requirements, so start by investigating several different banks and credit unions to determine which are most likely to loan you money based on your situation.
Qualifications
The amount of equity you need to qualify varies depending on the lender, where you live, and the loan terms. Generally speaking, you’ll need to have somewhere between 20% and 40% equity in your investment property to qualify. Lenders may also vary on how much they’ll allow you to borrow, but don’t forget that you’ll need to pay back all the money you’ve withdrawn once the draw period ends and the repayment period begins. Many financial institutions are reluctant to grant HELOCs on an investment property, so it may take time to find a willing lender. Finally, maintain a low debt-to-income (DTI) ratio to qualify for a HELOC on your investment property. Lenders typically calculate DTI by dividing your monthly debt payments by your gross monthly income. The maximum allowable DTI varies by lender, but in general, the bigger your down payment and the higher your credit score, the more likely your lender will allow a higher DTI. A low DTI is usually considered to be below 15%, and ideally, you should always aim to keep your DTI below 36%.
Interest rates
Expect to pay a higher interest rate for a HELOC on an investment property than you might for a HELOC on the home you live in. This is because banks consider lending money on investment properties to be riskier than granting a loan on a primary residence. Borrowers’ cash flow is often tied into multiple properties, which, in the lender’s eyes, puts them at a higher risk of default.
Reserve Requirements
Banks often require you to have a minimum amount of reserves, or liquid funds on hand, before qualifying you for a HELOC. The reserve minimum depends on a number of factors, including the loan amount, your credit score, occupancy, and the loan-to-value ratio. To qualify for a HELOC on your investment property, expect to need between 12 and 24 months’ worth of cash on hand, but The Balance has found requirements as high as 36 months of reserves.
Appraisal Process
Before qualifying you for a HELOC, your lender may require an appraisal to determine the current value of your property. How the appraisal is handled will vary according to your lender—in some instances, the appraiser may only need to drive by your property or review public records to assess its value.
Tips for Qualifying
Banks use several different criteria to decide whether or not to grant you a HELOC. You can control some of these factors—to an extent. If you’re looking to qualify for a HELOC on your investment property, make sure your credit score is as high as possible. This includes making on-time payments and keeping your credit utilization (the amount of debt you have outstanding compared to your credit limits) low. You’ll also want to try to maintain a favorable debt-to-income ratio; again, below 15% is generally considered good. Proof of income is also usually necessary to qualify, whether you’re an employee or self-employed. Finally, if you’ve got a rental property, make sure you’re able to provide proof of sufficient income from your tenants, along with any other intangibles that may make you a more appealing borrower, such as long-term tenants.
Downsides of Getting a HELOC on an Investment Property
Exercise caution when getting a HELOC. If you pay late or miss a payment, your interest rate may skyrocket, putting your property at risk. Since you’re putting up your property as collateral, you may be forced to sell or face foreclosure if you end up defaulting on the loan. HELOCS on investment properties may also have variable interest rates, which are based on market rates and can get expensive.
Pitfalls To Watch Out For
Lenders have varying criteria for HELOCs for investment properties. Shop around with multiple lenders to ensure you’re getting the best interest rates. You’ll also want to decide whether you’re looking for a regular or interest-only HELOC, as well as how long of a draw period you need. Finally, review the loan terms carefully to make sure they fit your situation.
