Is Using Home Equity To Buy an Investment Property a Good Idea?
Using home equity to buy an investment property is possible but, as with any major financial decision, there are benefits and risks to consider. Any time you tap your home equity, you’re putting your property on the line because it secures the loan. On the other hand, the potential returns from an investment property may make that risk worthwhile in the right circumstances.
Whether you’re looking to generate passive income, grow your real estate portfolio or buy a vacation home, here’s what you should know about using equity to buy another home.
- You can use a home equity loan, home equity line of credit (HELOC) or home equity investment (HEI) to tap home equity for real estate investments.
- Using equity to buy another property may make sense if you have limited cash savings.
- You’ll generally need a solid credit score and sufficient equity to qualify for financing, though requirements vary by lender.
Home equity is the difference between your home’s value and what you owe on your mortgage. That means if your home is worth $400,000 and you owe $300,000 on the mortgage, you have $100,000 in home equity ($400,000 – $300,000).
Loan options for using your home equity to buy an investment property
| Minimum home equity requirement
These requirements aren’t set by a single entity and may vary by lender.
| Minimum credit score
These requirements aren’t set by a single entity and may vary by lender.
| Best for borrowers who … | Loan type | Typical relative cost | |
|---|---|---|---|---|---|
| Home equity loan or HELOC | 15% to 20% | 620 to 680 | Don’t want to alter their existing first mortgage | Second mortgage | $$ |
| Cash-out refinance | 20% | 660 to 700 | Are comfortable replacing their existing mortgage with a new, larger loan | First mortgage | $ |
| Home equity investment | 25% to 30% | 500 | Have bad credit or low/no income and can’t qualify for a more mainstream loan | Equity-sharing contract | $$$$ |
1. Home equity loan
With a home equity loan, you receive a lump-sum payment that you repay in monthly installments over a set term. Learn more about the home equity loan requirements you’ll need to meet before applying for one.
2. HELOC
A HELOC, on the other hand, is a credit line you can withdraw funds from as needed — similar to a credit card. One key difference is that home equity loans generally have fixed interest rates, while HELOC rates are often variable.
Learn more about how to choose between a home equity loan and a HELOC.
3. Cash-out refinance
A cash-out refinance involves paying off your current mortgage with a new, bigger loan. You can then take the cash difference and use it for almost any purpose — including a new real estate purchase.
4. Home equity investment (HEI)
An HEI — also known as a “home equity contract” — is a way to convert a portion of your home equity into cash without having to make monthly payments. You won’t have to pay interest, either, and you typically won’t have to pay back the amount stipulated by the contract until you sell the home or the contract term ends (usually after 10 to 30 years).
Instead of charging interest, the home equity investment company takes a share of your home’s appreciation. But HEI contracts are usually more complicated than a simple percentage calculation, as lenders create a unique formula that determines how much they will get paid. The exact contract you sign matters a lot, and truly understanding the fine print can be difficult.
How to use equity to buy another house: 5 steps
When you use home equity to buy an investment property, you’ll typically tap the equity in your current home through a new loan, then use some or all of the cash you receive toward the down payment and closing costs on the new property. You’ll still generally need a separate mortgage to finance the investment property’s remaining purchase price.
1. Calculate your home equity.
The first thing to figure out is how much equity you have to work with. Once you calculate your home equity, you’ll have a better idea of the amount you could put toward buying a new property. To determine your home equity, use this simple formula:
Home value – Mortgage balance = Home equity
Find out how much you could borrow with a second mortgage using our home equity loan and HELOC calculator.
2. Determine how much you need for the investment property.
Next, estimate how much cash you’ll need to complete the purchase, including the down payment, closing costs and any required cash reserves. For example, if you’re buying a $400,000 investment property and need an $80,000 down payment, you might use proceeds from a HELOC, home equity loan or HEI to cover some or all of that $80,000.
An investment property mortgage would generally finance the rest of the purchase price.
3. Assess your finances.
You’ll want to take an honest look at your finances to see where things stand in terms of your credit score, income and debts.
You may need to qualify for two separate transactions: the financing used to tap your existing home equity and the mortgage used to purchase the investment property. That means you’ll need to keep in mind that:
- If you use a home equity loan or HELOC, the additional monthly payment could also affect your debt-to-income ratio and your ability to qualify for the investment property mortgage.
- An HEI generally doesn’t require a monthly payment, but the investment-property lender may still need to evaluate the obligation and source of your down payment funds.
You can check your Equifax, Experian and TransUnion credit reports for free on AnnualCreditReport.com. If your credit score has dropped since getting your first mortgage, it may make sense to address the factors impacting your credit before applying for a second mortgage.
Don’t know your credit score? Get your free score on the LendingTree app today.
4. Compare ways to tap your equity
Compare a home equity loan, HELOC, cash-out refinance and HEI based on how much cash you can access, qualification requirements, monthly payments and total financing costs.
A home equity loan may work well if you know exactly how much you need for the down payment, while a HELOC can provide more flexibility if you also expect to pay for renovations or other expenses. A cash-out refinance replaces your existing mortgage with a larger loan, while an HEI lets you access equity without a traditional monthly loan payment.
5. Apply for financing and purchase the property
Once you’ve chosen how you’ll borrow from your equity, you can put those funds toward the investment property purchase. Be prepared to document where the money came from, as lenders typically need to confirm that the funds used are legitimate and eligible under their rules.
Should you use home equity to buy an investment property?
Using the equity in your home to purchase an investment property can be a good option, but it’s not a one-size-fits-all solution. Here are a few reasons someone may choose this path:
- You don’t want to drain your savings. Tapping into your home equity allows you to invest in another property while keeping your savings intact. This can be particularly important if you know you’ll need cash for home repairs.
- You want to jump on an investment opportunity. HELOCs tend to have fast approval times, making it easier to jump on time-sensitive investment opportunities.
- You want to avoid taking on another monthly payment. An HEI can help preserve your monthly cash flow, since there’s no required monthly loan payment.
- Your returns would outweigh the costs. If the investment property will generate enough returns to offset the costs of borrowing, then it could be a good idea to invest. You should look at the full picture by comparing expected net rental income or sale proceeds against all the costs of purchasing and taking out an equity loan.
Learn about more ways to use your home equity.
Suppose you buy a $400,000 rental property and use an $80,000 home equity loan for the 20% down payment. You finance the remaining $320,000 with an investment property mortgage.
Here’s what the monthly numbers could look like:
| Monthly income and expenses | Amount
This example is for illustration only. Actual interest rates, rents, taxes, insurance and other costs vary.
|
|---|---|
| Rental income | $3,500 |
| Home equity loan payment (8% interest rate) | ($765) |
| Investment property principal and interest payment (7.5% interest rate) | ($2,237) |
| Property taxes | ($400) |
| Homeowners insurance | ($125) |
| Maintenance and vacancy costs | ($350) |
| Estimated monthly cash flow | ($377) |
In this example, the property brings in $3,500 per month but costs about $3,877 per month to finance and operate, leaving an estimated $377 monthly shortfall.
That doesn’t necessarily mean the investment will lose money overall. Part of each mortgage payment will build equity, and both the rental rate and property value could increase over time. But it does show that the rental income alone wouldn’t cover the estimated monthly costs.
And don’t forget: you’d also still have the mortgage on your primary residence.
Pros and cons of using home equity to buy an investment property
Pros
- You’ll have access to capital: Using your home equity gives you access to funds without depleting your savings account or selling other assets.
- You could make a larger down payment: If using some of your equity can help you make a bigger down payment, you could end up with better loan terms on your investment property loan.
- You may get a lower rate: Home equity loans and HELOCs generally have lower interest rates than personal loans or hard money loans. Cash-out refinance rates are usually even lower, because they’re first-lien mortgages.
- You could avoid monthly payments: If you choose an HEI, you usually won’t have to repay the principal balance or the financing costs for many years.
Cons
- You could have to juggle multiple mortgage payments: If you choose a second mortgage, you’ll be responsible for three different mortgage payments: your current mortgage, the home equity loan or HELOC payment and the mortgage on the investment property.
- Your home value could drop. With real estate, there’s always a risk that home values could fall and cause you to become underwater on your mortgage.
- You’re turning an asset into debt: When you use home equity to buy another house, you’re essentially converting an asset (the home equity) into debt and putting your home at risk of foreclosure if you default on the loan.
- Can complicate refinancing: You may need to pay off your home equity loan, HELOC or HEI before closing on a new mortgage. That can limit your ability to sell, refinance, or take out additional financing secured by the home.
- Can be difficult to predict. HEI formulas can be very complex, and they’re based on a big unknown: how much your home will appreciate or depreciate over several years. This makes it difficult to plan ahead or fully understand what you’re signing on for.
Alternatives to buying an investment property with equity
If you want to leave your home equity alone but still want to buy an investment property, some other options include:
- Hard money loan. Hard money loans are short-term, high-interest-rate loans that are typically secured by the property you’re financing. Private companies and investors offer these types of loans, which usually must be repaid within six to 24 months.
- Peer-to-peer (P2P) loan. P2P loans are funded by individuals or groups of investors and, unlike some of the other options available, they typically don’t require collateral.
- Personal loan. A personal loan is another option to get your hands on some cash, but keep in mind the interest rate will typically be higher than rates on a home equity loan or HELOC.
- Seller financing. With a seller financing arrangement, the home seller — not the mortgage lender — provides funding to the homebuyer to buy a property.
Frequently asked questions
It’s possible to take out a home equity loan on an investment property, but it may be more challenging than getting one on your primary residence. To qualify, you’ll typically need a strong financial history and sufficient equity in the investment property.
Yes, you can pay off a HELOC early — and doing so can help you save on interest and lower your monthly payments. Many real estate investors use this strategy after completing a fix-and-flip project, using the sale proceeds to pay off what they owe. One caveat: Check your loan agreement — some lenders charge a prepayment penalty for repaying a HELOC early.
Whether you should use a home equity loan or a HELOC depends on your financial picture and how you plan to use the funds. A home equity loan may make sense if you want a chunk of money upfront and fixed, predictable monthly payments. If you want ongoing access to funds for multiple purchases or repairs, a HELOC is likely a better fit. Both options involve taking on an additional payment and using your home as collateral.
Compare Home Equity Offers