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A home equity loan allows you to tap the equity in a property to obtain a one-time lump sum you can use for any purpose. You might be able to get a home equity loan on a rental property, although the process can be more challenging, and you could spend more with a higher interest rate.
Can you get a home equity loan on rental property?
The short answer: Yes, it’s possible to get a home equity loan on an investment or rental home. It’s also possible to use a home equity loan to help purchase this type of property.
However, in the eyes of a home equity lender, investment properties are riskier compared to primary residences. This is because you likely don’t rely on the rental to serve as the roof over your head, so there’s less at stake if you somehow become unable to repay the home equity loan.Because of this risk, it might be harder for you to find a lender willing to tie a home equity loan to an investment property. If you do find one, you’ll likely pay more in interest to compensate for that risk.
Requirements for a home equity loan on investment property
The requirements for a home equity loan on an investment or rental property vary by lender. In general, you can expect to need:
- Minimum credit score: 700 or higher
- Maximum debt-to-income (DTI) ratio: 43 percent (sometimes up to 50 percent)
- Maximum loan-to-value (LTV) ratio: 80 percent
- Reserves: Six months’ to 15 months’ worth of home equity loan payments
Risks of a home equity loan on rental property
Aside from the risk the lender takes on, you’ll be taking on some risk, as well. Similar to a mortgage, when you borrow against a home’s equity, you could lose the property if you fail to keep up with payments.In addition, if the property’s value decreases, you could find yourself underwater on the loan. This makes it much harder to offload the home if you decide or need to sell.
“If a recession starts, you run the risk of taking out more than the property is worth, and you might have a very difficult time selling it,” says Dick Lepre of CrossCountry Mortgage. “If interest rates are high, that depresses property values.”
Home equity loan on rental property FAQ
Yes, you can use a home equity loan to cover some or all of your expenses on a rental property. However, home equity loans are most useful for one-time costs, not necessarily the ongoing upkeep of an investment property. For this reason, it might make more sense to take out a revolving home equity line of credit (HELOC), either via the equity in your primary residence or the rental home itself, to pay for these expenses.
The interest on a home equity loan might be tax-deductible so long as you use the funds to buy, build or improve the property it’s tied to. The deduction applies to the combined interest on all of your mortgage debt, however, up to a certain threshold (depending on filing status). You’ll also need to itemize in order to take advantage of this tax benefit.
It largely depends on your real estate investing strategy. A HELOC generally offers more flexibility than a home equity loan because it’s a revolving line of credit, and you don’t have to pay interest on funds you don’t use. With a home equity loan, you’ll need to repay the entire amount you borrowed plus interest, regardless of whether you use it all to invest. In addition, you typically only need to pay interest during the HELOC draw period, which helps free up cash flow for other needs.
Yes, you can use the proceeds from a home equity loan to invest in a real estate investment trust (REIT). In fact, you can use the funds for any purpose. Some of the most common uses of home equity loans include paying for home renovations and college tuition. When considering a home equity loan, take your goals into account. Ultimately, a home equity loan is a second mortgage, so you don’t want to overleverage your finances without having a clear plan for the proceeds from the loan.