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Investment Strategy

How to Use HELOC for Investment Properties

If you’re in the property investment game, you’ve most likely come across the term HELOC.

A HELOC is a home equity line of credit and is a financing strategy that can be used by investors to grow their portfolios, fund renovations, and more.

In this article, we’ll take you through everything you need to know, from how they work, to the pros and cons of using HELOCs for investment properties, and alternatives.

What is HELOC?

A HELOC enables you to leverage the equity in your property as collateral for additional credit. In this sense, it’s like a second mortgage that you are able to take out even if you haven’t paid your original mortgage off in full yet.

For example, if your property is worth $200,000 and you have $100,000 debt, you will also have equity of $100,000. The bank will determine how much to lend you based on this figure.

When you sell a property using for example, a cash out refinance, although you gain access to your equity, you no longer have the property itself, not to mention the various fees associated with selling in the first place. In comparison, using a HELOC for investment property acquisition is often seen as a more attractive financing strategy. It is a way of tapping into your existing equity, without having to sell your property.

Essentially, instead of selling the property realising taxable gains, paying associated fees and taxes and then looking to reinvest funds, a HELOC allows you to access locked away cash to reinvest. And you keep the existing property.

Do HELOCs come with interest?

As with most home loans, there is interest on HELOCs. Interest rates are typically higher than mortgage interest rates but considerably lower than credit card rates. The rate is often under 5% but varies depending on the lender. The interest rate is also not locked and can sometimes fluctuate on a monthly basis.

Many HELOCs are interest-only during the draw period. This means that the borrower only has to pay interest on the money withdrawn during the draw period (typically between 5 and 10 years). After this time, when you are in the repayment period, you will be expected to pay the interest and the principal.

With all of this being said, it’s important to note that you are able to negotiate rates and terms with lenders when first applying for a HELOC. It’s wise to take advantage of this to get the best deal. After your term comes to an end, the lender will reevaluate the terms of the loan and update them accordingly.

property equity

What are the requirements to get a HELOC for an investment property?

Unlike traditional mortgages, HELOCs are not as heavily regulated, so banks have some liberty when it comes to setting interest rates and terms.

Nonetheless, to be eligible for a HELOC, you still need to meet a number of criteria. Individual banks will have varying guidelines that determine how much they can lend you, based on the property value and your credit. It pays to shop around for your HELOC, to see what kind of deal you can get.

Some of the key considerations that banks look at when issuing HELOCs for investment properties are as follows:

  • A maximum combined loan-to-value ratio of 80%
  • At least 15% equity in the property
  • A credit score of 620 or higher
  • Ability to pay the loan back
  • Healthy cash reserves

Can you use a HELOC on rental property?

It goes without saying that many investors take out a HELOC against their primary property to start with. You can however, take out a HELOC on an investment property (such as a rental), but this is considered by lenders to be riskier. As such, the rates you are offered for a HELOC on an investment property may not be as favorable as those offered on a primary residence. This is considered a non-traditional HELOC.

Due to the higher risk of a HELOC on a rental property, there may also be additional eligibility requirements that need to be met such as:

  • At least 20% equity in the property
  • A credit score of 720 or higher
  • Reasonable tenant turnover (indicative of your financial stability)
  • Sufficient income from tenants
  • How easy it would be to rent your property out in the future

Note: Landlord Studio users can instantly generate a number of reports for this purpose, including a  rent roll report and rent ledger report which detail key information such as rent payment history, current and historical tenancies, and vacancy periods.

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How to use a HELOC

Once you have secured a HELOC from your lender, it is up to you as the borrower to decide how you spend the money. Most obviously, a property investor might use a HELOC to grow their portfolio by acquiring new properties. There are also additional ways to use a HELOC.

Diversification of your portfolio

Using the money from a HELOC, an investor can diversify their portfolio by branching out into short-term rental properties, multi-family properties, or single-family properties.

Geographical diversification

Financing can also allow for the geographical diversification of a portfolio as investors may choose to invest in out-of-state rental properties for example.

Upgrade your existing properties

Once you have secured a HELOC, you are not limited to investing in new properties. You can also use the money to upgrade your current properties. This could mean maintenance or extensive improvements and renovations to increase rental returns.

Debt consolidation

Depending on the interest rates of the HELOC and any existing loans, a property investor may choose to use their HELOC to consolidate debt. If the interest rate is low enough, this may be a viable strategy to better manage debt.

Pros of using HELOC for investment property

There are many benefits to using a HELOC for investment properties. Some of these are as follows:

  • You are not using your own money so you do not need to save as much
  • It allows you to grow your investment portfolio
  • HELOCs are an interest-only loan (for the initial draw period)
  • You can use the same line of credit repeatedly
  • You can choose when to withdraw the money depending on when you need it
  • Interest rates are considerably lower than on credit cards

Cons of using HELOC for investment property

Despite there being many good reasons to use a HELOC for investment property, there are also some drawbacks to take into consideration. Some of these are as follows:

  • It is not available to everyone – you need to meet the requirements
  • It is dependent on your existing equity – you can’t just take out any amount you want
  • It is still a loan that needs to be repaid
  • Interest rates are variable and not always fixed for a long time

Alternative financing strategies

Given the pros and cons of HELOCs, if you do not feel that they are the best strategy for you but you don’t have cash available to grow your portfolio, there are alternative financing options available. Some of these are:

Credit cards

Instead of relying on your property equity, credit card limits are based on your credit. Like HELOCs, you only pay interest on whatever you borrow. However, interest rates are notoriously high, so it’s wise not to use credit cards unless you are sure that you can definitely pay the balance in full every month.

Cash-out refinancing

With a cash-out refinance, you can take out a larger mortgage on your property. Instead of increasing the monthly payments, the length of your mortgage is extended. Unlike HELOCs, you can lock the rate for 30 years. Do keep in mind that you cannot refinance a property if you already have a HELOC on it.

Private loans

Private or personal loans tend to be more flexible and varied in their interest rates and term lengths, in comparison to loans from banks. Taking out a private loan can be a good option if your credit score is not attractive enough to traditional lenders. Due to the term lengths often being shorter though, it can put pressure on you as the borrower to pay back sooner. There are also fewer protections.

Final words: HELOC for investment property

HELOCs are a financing strategy that allow property investors to grow their portfolio through further investment, even when they are still paying off debts from current properties. They are a way of leveraging equity off an existing investment.

Depending on what you are financing (new property, maintenance, etc.), interest rates and the set terms, HELOCs can be a good option. They can allow you to diversify your portfolio without having to sell existing property.

Disclaimer

We hope you found this blog interesting! However, do note that the information in this article does not constitute advice. This blog is for general informational and educational purposes only and should not be used as a substitute for competent legal and/or other advice from a licensed professional.

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Ben Luxon

Ben is the editor and lead writer for Landlord Studio. He has worked with real estate professionals all over the world and written educational articles on tech, real estate, and financial growth for sites such as Forbes, TechBullion, and Business Magazine.

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