Using A Home Equity Loan On An Investment Property: A Guide
If you want to buy an investment property, there are several different financing strategies you can use. One option is to use a home equity loan to purchase the property. A home equity loan allows you to borrow money by tapping into your home’s equity.
However, there are some risks to using a home equity loan to purchase an investment property. This article will outline the steps you can take to apply, and some things to think about first.
Home Equity Loan Overview
A home equity loan allows you to borrow money by tapping into the equity in your home. You’ll receive a one-time lump sum payment and repay the loan in monthly installments. This differs from a HELOC, which is an ongoing line of credit.
The advantage of taking out a home equity loan is that the funds can be used for nearly any purpose. And you’ll receive a fixed interest rate on your loan, so your monthly payments will stay the same each month, making them easier to budget for.
Can You Get A Home Equity Loan To Buy An Investment Property?
Yes, you can use a home equity loan to purchase an investment or rental property. But there are risks involved with using a home equity loan to buy an investment property, such as putting your primary residence at risk if you default on the loan.
Requirements For A Home Equity Loan To Buy A Rental Property
Before you can take out a home equity loan to purchase an investment property, you’ll need to meet the following requirements:
- Credit score: Lenders will look for excellent credit, so you’ll need a credit score of 680 or higher to qualify for a home equity loan.
- Loan-to-value ratio: Before you can take out a home equity loan, lenders will look for a loan-to-value (LTV) ratio of 75% or lower.
- Debt-to-income ratio: You’ll need a maximum debt-to-income ratio of 50%.
- Cash reserves: Most lenders will want to see that you have a minimum of 6 months’ cash reserves.
The Pros And Cons Of Using A Home Equity Loan To Buy An Investment Property
There are advantages and disadvantages to using a home equity loan to purchase an investment property. Here are a few things you should consider before taking out a home equity loan:
- Buying an investment property is a good way to earn passive income.
- Home equity loans come with lower rates than most other types of loans.
- You’ll receive a fixed-interest rate on the loan.
- Your loan payments will stay consistent each month, making it easier to budget for the loan.
- If you default on the loan, you put your primary residence at risk.
- The home’s value could decrease, making it difficult to sell the property.
- There’s no guarantee you’ll see a return on your investment.
How To Get A Home Equity Loan For An Investment Property
You’ll need to take the following steps to apply for a home equity loan to purchase an investment property:
1. Review Credit History
You’ll need excellent credit to take out a home equity loan, so you should review your credit score before applying. You can request a free copy of your credit report from AnnualCreditReport.com to ensure all of your information is correct.
If your credit score is lower than you would like, you may want to take steps to improve it before applying for a home equity loan. You can also consider applying with a co-signer to improve your odds of approval.
2. Get Financial Documents
Next, you’ll need to gather the financial documents your lender will need, such as a government-issued ID and Social Security number to verify your identity. You’ll also need to provide your address and birthdate.
Your lender wants to see that you have a recurring source of income, so you should provide your W-2 and pay stubs. You’ll also need to provide bank statements and tax returns so your lender can review your financial history.
3. Compare Lenders
It’s important to compare mortgage lenders to get the best rate for a home equity loan. As you receive offers, look for a lender that offers low rates and flexible repayment terms. And watch out for any additional fees which can drive up the total cost of the loan.
Home Equity Loan For An Investment Property: FAQs
If you have additional questions about taking out a home equity loan to purchase an investment property, the answers to the following frequently asked questions might help.
Should I use a home equity loan to buy a rental property?
Using a home equity loan to buy a rental property can be a good way to diversify your investments and create a source of passive income. But you should make sure you can afford the monthly payments so you don’t put your primary residence at risk.
Is a HELOC better to use versus a home equity loan?
Whether you should take out a HELOC or home equity loan depends on the situation. A home equity loan is better for a one-time purchase while a HELOC is better for ongoing expenses where you don’t know the full costs. And a home equity loan is a better option if you want a loan with fixed rates.
Is a home equity loan tax-deductible?
The interest paid on a home equity loan is tax-deductible, assuming you used the funds to buy a home or make improvements to one. But the interest isn’t tax-deductible if you used the money to buy an investment property. Be sure to consult a tax professional regarding your eligibility.
The Bottom Line
It’s possible to use a home equity loan to buy an investment property, but you should consider the risks involved. If a home equity loan isn’t an option for you, there are some alternatives you can consider. But if you’re ready to get started, you can fill out a home equity loan application today.