Exploring a HELOC for Purchasing Investment Properties

Over the years, I’ve had quite a few property owners who were low on funds ask me, “Can you get a HELOC on an investment property?” My answer to them was always, “Yes”. I’ve used the rental property HELOC strategy more times than I can remember, and it’s significantly grown my portfolio and wealth. If you’re unfamiliar with the term HELOC, it stands for home equity line of credit, and I’ll go into detail on exactly what it is, who qualifies for a HELOC, and more.

Before jumping in, though, I’d like to express that a HELOC can provide a homeowner with an easy way to tap into their property’s equity that’s just sitting there, not being utilized. In addition to this, because it’s a line of credit, the borrower starts with a zero balance and only pays interest on what’s used, as compared to a cash out refinance for investment property purchases where the interest clock starts ticking from day one on a huge balance.

Now, with all that said, let’s dive into some key details regarding a home equity line of credit…

What is a HELOC?

A HELOC is a revolving line of credit that’s secured by a property’s equity. It’s similar to a credit card, where you’re given a limit and the balance starts at zero. These funds can be withdrawn as needed within a draw period, during which the borrower makes interest-only payments on the used balance. In about five to ten years, the draw period ends, and full repayment starts. A property owner can typically borrow up to 80 to 90% of the home’s built-up equity. To access the funds, a debit card and checks are provided, along with the ability to do bank transfers.

Can You Get a HELOC on an Investment Property?

Because this is a common question I get from fellow investors as well as those just starting out, I’d like to address it head-on. When most people hear the term home equity line of credit, they commonly think it’s funds that are only used for renovations and repairs on a homeowner’s personal property. Oftentimes, this is the case. However, when you take a line of credit out such as this, it can actually be used for anything, even groceries. That said, a HELOC can be used to purchase rental real estate. I put together an entire article on this same question – Can You Use a HELOC on Rental Properties? It goes through the steps of how to get started using a HELOC for investment properties, so it’s worth diving into.

Eligibility Criteria: Who Can Apply for a HELOC On an Investment Property?

Now that you know you can actually use this funding method to invest in real estate, the next question is, do you meet the eligibility criteria for being able to take out a rental property HELOC? The good news is that there are no rules and regulations specifically for using a home equity line of credit on a rental property, but instead, one set of rules for all who apply, no matter what their intended use is.

So, for those asking, “Can you get a HELOC on an investment property?” the answer is that you can, as long as you meet certain “overall” criteria, which I’ll cover below:

1. The Property Owner Must Have Enough Equity to Work With

First and foremost, if you don’t have equity, then it goes without saying that you have nothing to borrow against and, therefore, would not be eligible for a HELOC. Basically, to have enough equity, the amount you owe on your mortgage must be less than the property’s current value, and it should at least be 15-20% of equity. Here’s a formula you can use to calculate how much equity you currently have:

Home Equity = Market Value of the Home – Outstanding Mortgage Balance

2. Must Be In Good Financial Standing

Lenders will check certain criteria to ensure the borrower is in good financial standing. This means they typically want to see about 18 months of liquid reserves to ensure payments will continue even if something unfortunate were to happen, like the loss of a job. The bank will also check the basics, which includes your credit score and credit history, employment and income-to-debt ratio, and the like.

If you pass these standard checkpoints, then you should be eligible for a rental property HELOC.

Pros & Cons of a Home Equity Line of Credit

If you’re considering using a HELOC for investment properties, it’s best to first look into the risks and benefits of this financial product. It would also be wise to compare a home equity line of credit to other options, such as a home equity loan or a cash out refinance for investment property purchases.

Let’s start with the PROs of using a HELOC…

HELOC PROs

A home equity line of credit offers a few key advantages, particularly in terms of cost and flexibility. One of the main PROs is that a HELOC typically offers lower interest rates compared to credit cards, traditional loans, as well as home equity loans. In addition to this, HELOCs start the borrower out with a zero balance and they draw from that as little or as much as they would like. This has a huge advantage over traditional loans that start charging interest from the very beginning on a huge lump sum, which is the full balance of the loan.

Another benefit is that HELOCs allow for interest-only payments during the draw period which can keep monthly payments manageable. Also, the borrower can draw from the HELOC, repay it, which restores the credit line, and then borrow again, something that can’t be done with most traditional loans.

Using a home equity line of credit also provides the advantage of being capable of investing when you don’t have the funds to do so. 

HELOC CONs

I’d say the biggest CON of a HELOC is that the borrower puts the property up for collateral. This means that if the owner defaults, the bank can take possession of the home. However, if you know you’re good for the money, then it shouldn’t be an issue.

HELOCs generally have variable interest rates, and while some feel this is a PRO, many more feel it’s a CON, especially in today’s economy, where rates have been on an upward trend. Keep in mind that rising rates will make your monthly payments rise right along with them.

If you’re financially responsible, then you won’t have to worry about this next CON, which is the ability to use a home equity line of credit for any type of purchase, from a night at the movies to buying products on Amazon. As you can imagine, this could quickly rack up the loan bill if allowed to get out of hand.

HELOC vs Cash Out Refinance for Investment Property Purchases

Because investors frequently ask me which is better, a HELOC or a cash-out refinancing for additional investment funding, I’d like to spend a minute on this topic.

A cash-out refi is similar to a HELOC in that you can leverage your property’s equity. However, the difference is that while a HELOC is simply a line of credit that draws off the property’s equity, a cash-out refi is a whole new loan on the available equity, and this is where the word “refinance” comes into play.

How it works is the cash-out refinance replaces the original home loan and provides a lump sum for the borrower – in simple terms, the borrower will have a new mortgage because the original is cashed out. The problem I have with this when comparing it to a HELOC, is the issue I mentioned earlier. A cash-out refi sets you up with a brand new loan where interest accrues on a large amount of money on day one.

Speaking of interest, if your original loan had a low interest rate locked in, you’ll lose that rate and replace it with whatever the going rate is. This could be a big issue if your original loan was signed before rates started to skyrocket over the past few years. This alone would make it not worth doing a cash-out refinance because it will end up costing you thousands more in the long run. Along with this, because it’s a new mortgage loan, you’ll be responsible for new closing costs and fees.

Because of these costly CONS, I prefer to use a rental property HELOC over a cash out refinance for investment property purchases.

Here’s a great video I put together on the differences between these two financial products: