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For homeowners seeking to access the equity in their rental property, getting a home equity line of credit (HELOC) can be a great option. This potentially doubles the size of your credit line, especially if you already own both your primary residence and investment property. However the standards for lending on investment properties, like rentals, have been significantly tightened in the wake of the financial crisis. Borrowers may find rental-based credit harder to obtain than a home equity loan on their primary residence.
- Can You Get a HELOC on an Investment Property?
- How do HELOCs on Investment Properties Compare with Primary Home Loans?
- How Can I Get a HELOC on My Investment Property?
- What Are Some Alternatives to Investment Property HELOCs?
Can You Get a HELOC on a Rental Property?
It is possible to get a home equity loan on a rental property, but it’s more complicated than it used to be. The qualifying criteria are stricter, and home equity lenders are focused on ensuring your ability to repay. Lending on investment properties is more expensive in general, and interest rates are higher than for primary homes.
Note that we discuss the process of cashing out home equity from your investment property below. If you're interested in buying a rental property using the home equity from your primary residence, read our guide here*).
How Do HELOCs on Rental Properties Compare with Primary Home Loans?
Banks hold higher credit standards for HELOCs drawn on investment properties because they are more susceptible to default than loans on primary residences. Homeowners with multiple properties are more likely to accept default on an investment property than on their primary home. Since home equity loans are often the second or third lien on a property, home equity lenders are less likely to recover their funds in a foreclosure.
Home equity lenders compensate for this extra risk by charging higher interest rates and requiring stricter underwriting standards. This goes double for investment homes. Being able to qualify for a HELOC or second mortgage on your primary home doesn’t always guarantee that you’ll qualify for the same type of loan on an investment property.
The hurdles for investment property loans are numerous and the interest rates are generally higher than they are for home equity loans on primary residences. We list the main differences between second mortgages on primary residences and investment properties below:
|Primary Residence Equity Loans||Investment Property Equity Loans|
|Higher LTV/CLTV/HCLTV allowed||Lower thresholds for LTV/CLTV/HCLTV|
|Lower interest rates||Higher interest rates|
|Lower or no reserve requirements||Significantly higher reserve requirements|
|Straightforward appraisal process, may even use an existing appraisal||May require two appraisals and 12-month waiting period from the initial purchase|
Overextending yourself financially by taking on too much mortgage debt is a real possibility. Many investors were caught off guard in 2008 by the sudden implosion of demand in real estate. To avoid distress, treat HELOCs like credit card accounts tied to your equity—don’t draw any more from your line than you can comfortably repay in full. This can prevent a financial tool from becoming a burden later on.
How Can I Get a HELOC on my Rental Property?
Get your DTI in Line: Your debt-to-income ratio must fall within an acceptable range for the lender. Your front-end DTI is made up of your housing expenses, including principal, interest, taxes, insurance, plus any HOA dues and your new home equity line monthly payment.
Your back-end DTI will include all installment and revolving debts from your credit report. When it comes to home equity loans, lenders are most concerned with your back-end or total debt-to-income ratio, from an underwriting standpoint. Acceptable ranges may vary depending on which bank you’re working with.
Know Your LTV Requirements: Your loan to value is limited to a certain percentage for most loan programs, and it’s determined, in part, by an appraisal. For home equity loans, LTV requirements can include combined loan to value (CLTV) and high combined loan to value (HCLTV) limits.
CLTV consists of the current balance of all loans divided by the home value. By contrast, the HCLTV consists of the entire credit line available on all loans divided by home value. It’s important to keep in mind that underwriting decisions for home equity loans will be based on the entire credit line, not just your initial draw.
Maintain a High Credit Score: Lenders rely on credit scores to determine whether you qualify for a loan, and what terms you’ll receive. The better your credit score, the more likely you are to qualify for the best interest rates and loan terms.
Having derogatory information on your credit report could derail your entire loan application, especially if it’s something egregious like a foreclosure, bankruptcy, or a tax lien. It's, therefore, important to make sure all the details on your credit report are accurate prior to applying for any kind of loan.
Build Cash Reserves: For investment properties, having cash reserves equal to a certain number of months’ payments is a prerequisite for most lenders. It can vary from just a few months to 18 or even 24 months’ worth of cash on hand. A HELOC or home equity lender may even require that you have enough in reserve to cover the entire credit line they extend on your investment home.
What Are Some Alternative to Rental Property HELOCs?
There are other products besides home equity loans that you can use to tap into your equity or otherwise borrow funds:
Cash-out refinancing: allows you to rewrite an existing mortgage for a higher amount and receive the excess funds at closing. The qualifying criteria are stricter and highly regulated for first mortgages, but the rates and terms are more favorable (due to less risk for the lender).
Cross-collateralization: is a unique lending tool that allows you to group two or more properties under the same overarching loan. This can make access to the equity in your investment property more straightforward, as it’s effectively pooled with the equity in other properties. The drawback is that it can be difficult and costly to separate interest in the properties (and proportionate debts) later on.
Unsecured personal loans: or signature loans are another alternative if you are looking for options that don’t require you to leverage your equity. Since these loans aren’t tied to collateral (i.e., equity in a property), the interest rates will depend solely on your credit score and debt to income ratio, and are typically higher than rates for mortgage loans and HELOCs.