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- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
HELOC on Investment Property
It can be challenging for taking out a home equity line of credit (HELOC) on your main home. Though it is possible, but not any easier to get a HELOC on investment property that generates rental income.
A HELOC can allow you to make improvements to your property or fund other financial goals, if your financial position is good as a real estate investor, and if you can find a lender who is willing to work with you.
So if you are intending to use a HELOC on investment property so today let us look at some tips and tricks on buying an investment property using a HELOC as well as the pitfalls to avoid when buying using a HELOC on investment property.
How does a HELOC work?
It is a type of the second mortgage that works like a credit card. Access to a credit line with a set dollar amount is defined by your lender, and you draw on that credit line up to the limit as needed.
This credit line period is called the draw period and lasts for a certain period of time like 10 years and during this time you will make interest-only payments and once the draw period is over you cannot draw anymore and must start making principal and interest payments until your full borrowed balance is repaid.
Let us suppose you have a HELOC limit of $100,000, a HELOC works very similar to a credit card, and we take that $100,000 limit to buy an investment property, so half of the HELOC would be $50,000 which could be used to buy an investment property outright without any liens or other debt so we have a $50,000 balance and this property will generate a $1000 in terms of cash flow.
There is no restriction on the way a HELOC fund needs to be spent, It can be utilized for –
- Home improvement purpose
- For consolidating debts with high-interest rate
- Buying investment property.
How to find a lender for an investment property line of credit?
You may have to do a little digging to find yourself a lender who offers HELOCs on investment properties as they are hard to come by, due to the increased risk that an investment property line of credit brings.
A potentially effective way is through word of mouth to find a HELOC investment property lender.
When you join local and regional real estate investing groups they will recommend you a lender. You could also try online real estate communities as they are another way of searching for resources.
If you are facing financial hardship that reduces your income as an investor, it is expected that you’ll always first cover the mortgage payments for your main home.
In that situation repaying a line of credit on a rental property is not the top of your list of priorities.
If by chance you happen to lose your rental property to foreclosure the sale proceeds would pay off your first mortgage, then whatever’s left would go toward repaying your HELOC.
Ways to get a HELOC on investment property
Compared to HELOC on a primary residence, investment property line of credit requirements are stricter, The qualification includes having a higher credit score and plenty of cash reserves. A lender typically requires –
- The minimum credit score of 720 -740
- Maximum loan to value ration of 80%
- Occupancy of the property by a tenant for a longer-term.
- A good amount of liquid cash reserves of at least 18 months worth
- Due to more risk involvement, higher interest rates for investment property compared to owner-occupied homes.
- Lenders may also require confirmation of you paying rental income on those properties, and not owing to another debt.
There is a high possibility of you having to pay closing costs, and also a home appraisal fee, title search fee, and document preparation fee.
For HELOCs on primary residences, lenders may waive these costs, but for a HELOC on an investment property that may not be the case.
How can you be careful with the HELOC investment property deal?
If you already have a HELOC or you are looking to get a HELOC then we suggest you use less than 50% of the total HELOC limit so if you have a $100,000 HELOC limit use only $50,000 or less so you will be protecting yourself from a possible recession and its negative impact.
Another thing is that don’t exceed more than 70% of the combined debt when it comes to your home or your residents so for example – if you have a home or your primary residence is worth $100,000 we suggest do not exceed more than $70,000 in total debt on this home value again going back to protecting yourself from a possible recession.
The idea here is we don’t have to owe more than what our home is actually worth.
Conclusion
There is always a possibility of overextending yourself financially by taking on too much mortgage debt.
The recession in 2008 caught many investors off guard by the sudden implosion of demand in real estate.
To avoid distress, treat HELOCs like credit card accounts tied to your equity and avoid distress by not drawing any more beyond your line of comfort because it can become a burden at a later stage.
