Can You Get a Home Equity Line of Credit on an Investment Property?
An “investment property” is typically a home you own, but do not use as your primary residence. Most homeowners who take out a home equity line of credit on investment property are using it on properties they rent out. And while it is possible, it does come with some challenges.
Challenges of Getting a Home Equity Line of Credit on Investment Properties
One huge reason that it’s a challenge getting a home equity line of credit on investment property is that you don’t occupy the home yourself. You’re much more likely to qualify for a line of credit on a primary residence than on a property you use for investment purposes.
Finding a Lender
Lenders typically figure that a person is more likely to keep up payments on a mortgage if the consequences of not doing so include the threat of homelessness. That is a strong incentive to stay current on your account and one that is absent on investment properties.
That attitude was reinforced by the Great Recession, which was unkind to many smaller landlords. Buying a home with the intent to rent can be a great long-term investment. Unfortunately, the first few years tend to be particularly tough. Things usually get easier as rent rises and mortgage payments stay steady. Those early years are frequently a period when the owner of a rental home can be struggling to make ends meet at the end of each month.
Hit by a severe economic downturn, many landlords went under during the time frame of 2006-2009. In the eyes of financial institutions, investment properties owned by small landlords suddenly looked even more like bad lending bets.
That is why quite a lot of lenders still flat-out refuse to accept applications for home equity lines of credit secured by investment properties. Luckily, there are more obliging lenders. A good place to start is by comparing home equity lenders to see if they offer lines of credit on investment properties.
Qualifying for a Loan
If you’re able to overcome the challenge of finding a lender who’s willing to give you a home equity line of credit on investment property, you may run into a second challenge of being able to qualify.
Typically, the lenders that entertain applications on a home equity line of credit on investment properties will set stiffer underwriting requirements than they would on owner-occupied properties. In other words, the lending criteria they use when assessing an application is stringent. If your financial circumstances are difficult, you may need to speak to a few lenders before you find one that will accept your application.
Although some lenders say they will allow a loan-to-value ratio of 80 percent, many set that cap at 75 percent. That means the borrowing limit on your new HELOC, plus the balances on any existing first and second mortgages secured by the home, cannot total more than 75 percent of the property’s appraised market value.
Equally, your lender may expect you to meet higher expectations across all the criteria it uses than if you were borrowing against the home you own and occupy. Those include:
- Your debt-to-income ratio – This is the proportion of your monthly debt payments against your monthly income. Lenders tend to look at applicant’s DTI ratios to determine if they could handle taking on more debt.
- Your credit score – You’ll want to drive this upward during the months before you apply for the line of credit by continuing to pay all your bills on time, reducing any balances on credit cards, and avoiding opening new accounts or closing old ones. Monitor your credit score to ensure that there aren’t any surprises lenders might come across when reviewing your application.
- Your open accounts – Expect close scrutiny of all your accounts, especially those relating to income and expenditure on the rental property that will secure your line of credit.
- A cash cushion – You may be required to have cash reserves. This shows that you can continue to make your HELOC payments even if your tenant moves out and leaves you with an income gap before you can find a new one.
What Happens if I Experience Both Challenges? Should I Lie?
A few years ago, a landlord was having trouble finding a home equity line of credit on investment property. He asked in an open chatroom whether he should lie on his application and say that the rental home was his primary residence. Another poster replied that he then owned eight investment properties, had done so for many years, and had falsely claimed on each application that he was going to live in them. He said, “It’s not a bad thing, besides, you get better terms anyway…”
You may question how smart that man was. His seemingly genuine profile, next to his post, included his forename, surname, home city, and photo. Also, he had just admitted to multiple counts of felony fraud.
Lying on a mortgage application (including those for home equity products, which are second mortgages) is generally a federal offense and is usually investigated by the FBI, sometimes assisted by state law enforcement. It comes with maximum penalties of 30 years in federal prison or $1 million in fines or both. True, it is unlikely you would suffer those for a single fraudulent HELOC application, but do you really want to be looking over your shoulder for years to come?
Alternatives to a Home Equity Line of Credit on Investment Property
Before considering the risk of relocating to a federal penitentiary, it is worth exploring some less extreme options:
Instead of taking out a second mortgage, which is what a HELOC is, refinance your first mortgage. If your new loan is bigger than your existing one, there should be cash left over (after costs) and you can use those funds as you see fit. This type of refinance option is called a cash-out refinance. It is especially attractive if you are refinancing to a lower interest rate.
There are downsides to this, which usually include higher closing costs compared to a home equity line of credit. Also, many lenders will apply tough qualifying criteria to a cash-out refinance application as they do on a HELOC on an investment property. Fortunately, there are upsides too, often including lower monthly payments overall.
You may think of a personal loan as something more suitable for borrowing a few thousand dollars, rather than more serious amounts. However, it is possible to borrow up to $35,000 with one of these.
In some circumstances, a personal loan can be a very good option. For example, they come with much lower set-up costs than HELOCs and refinances. So, if you need money for only a short time (a year or two, say), they can work out cheaper than equity-based loans – even though they typically come with noticeably higher interest rates.
Those higher rates are required because these installment loans are unsecured, meaning they are not guaranteed by an asset, such as an investment property. That decreases your risks but increases your lender’s risks. And it means that the lender is protected only by your personal creditworthiness. If things go wrong, it has no automatic right to seize your rental home.
Unsurprisingly, you will need a glittering credit score to borrow large sums. Plus, the bigger the amount you want to borrow, the more closely you can expect your personal finances to be scrutinized.
Whether you settle for a HELOC on an investment property or another loan option, be sure to shop around for the best deal. You are probably looking at borrowing large sums over a decade or more and even a slight variation in your rate can make a big difference to the total you pay in interest.