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You can use the proceeds from your home equity loan or home equity line of credit in any way you want—including on an investment or rental property.
Using your home equity to put a down payment on or purchase an investment property is possible, and is often one of the cheapest borrowing options you may have.
If you already have equity built up in a rental property, you may also be able to take out a home equity loan or HELOC against that equity. Just note that you may be eligible for less money than you would be with your primary home.
This article will focus on the first situation.
On this page:
- Using Home Equity for an Investment/Rental Property
- Risks of Using Home Equity for Investment Properties
- Differences Between Home Equity Loans & HELOCS
- Home Equity Loan & HELOC Tax Benefits
- Fast access to your equity without leaving home
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Using Home Equity for Investment or Rental Properties
Using your home equity to make a down payment or to fully purchase a rental property may be a good idea because it can help you secure low rates without having to go through the process of getting a second mortgage.
A home equity loan or HELOC can also be a good source of cash to make repairs or improvements on an investment property because the interest rates are much more favorable than other forms of borrowing, like credit cards and personal loans.
Most lenders will have a maximum combined loan-to-value ratio (LTV) of around 85%. This means that your mortgage and home equity loan can’t exceed 85% of your home’s current value.
For example, if your home is currently worth $200,000 and you have a mortgage balance of $120,000, your current loan-to-value ratio would be 60%. The maximum amount of debt you could have—including your mortgage and home equity loan—is $170,000 (85% of $200,000). This means the total amount of a home equity loan you could receive is $50,000 ($170,000 – $120,000).
Risks of Using Home Equity on a Rental Property
The biggest risk associated with using a home equity loan or HELOC is that your home serves as the collateral for the debt. While this is what allows you to borrow such a substantial amount of money at such a low interest rate, it is also what can cause a tremendously large loss if things go wrong.
If you can no longer make the payments on the home equity loan or HELOC, the lender will foreclose on the collateral property in order to fulfill your debt obligation. In this case, that is your primary residence.
Since the investment property does not serve as the collateral, that property may not be impacted by these financial difficulties. You would only face foreclosure on the investment property if you also have a mortgage on that property that you cannot pay.
In the end, you need to decide if you are willing to risk losing your home for your investment property. If it is a relatively high-risk investment property, you might be safer to consider another source of financing or finding a safer investment for your home equity.
The Differences Between Home Equity Loans and HELOCs
A home equity loan provides the borrower with a lump sum at closing based on the total amount of equity in the home. The borrower pays off the loan in fixed monthly payments over a period of 10 to 15 years.
A home equity line of credit is similar to a home equity loan because the maximum amount of credit extended to the borrower is dependent upon the total equity that the borrower has in the home. Unlike the home equity loan, however, the HELOC allows the borrower to use only the amount of credit needed.
The borrower can also continue to use the credit over and over again as it gets paid off. So, the funds are not available for one single-use as they are with a home equity loan.
Home Equity Loan & HELOC Tax Benefits
Prior to 2018, federal tax law allowed homeowners to deduct the interest they paid on their mortgage as well as their home equity loan or HELOC. At the beginning of 2018, however, the IRS added some qualifications to home equity debt tax deductions.
Under the current law, interest on home equity debt is only tax deductible if the homeowner uses the proceeds to make substantial improvements to the property serving as collateral for the loan. As a result, homeowners cannot deduct the interest if they use the proceeds to purchase or improve a separate investment property.
Author: Kimberly Goodwin, PhD