A home equity line of credit (HELOC) is a lending product that provides a loan based on the amount of equity held in a real estate asset. Typically, HELOC lenders will require the borrower to have 20% or more equity in the property already, which acts as security for the loan.
Traditional consumer personal loans have higher interest rates because they aren’t secured against anything. As a HELOC is secured against a property, the interest rate tends to be lower.
Because of this, HELOCs can be a great way for real estate investors to access funds. HELOCs on an investment property, done properly, can provide capital for future acquisitions or renovations. Here's an overview of HELOCs, the pros and cons of getting an investment property line of credit, and whether real estate investors should try to get in on the action.
What is a HELOC?
A home equity line of credit (HELOC) is a lending product that is secured against a real estate asset. Generally speaking, a HELOC on an investment property will give you a pool of money you can choose to access. This is an important distinction from a refinance, which would put all the money in your account at once.
With a HELOC, you will be given access to a certain amount of funds, but similar to a credit card, if you don’t spend it, you won’t be charged any interest. This gives investors a lot of flexibility to use or hold on to this capital and deploy it strategically.
As you pay off the balance, those funds will then become accessible to you again. For instance, if you use $50,000 from a $100,000 HELOC on an investment property renovation project, you will only be charged interest on $50,000, until it’s paid back in full, then you have access to the entire $100,000 again.
HELOCs generally have an expiry date of 10 or so years but can be easily extended or closed.
HELOC on an investment property example
- An investor owns a duplex with a market value of $500,000.
- The current mortgage balance is $250,000.
- Your lender allows for up to 80% LTV on a HELOC.
In this example, the real estate investor would have $250,000 in equity in their property. With a lender’s 80% LTV, that means they would allow the investor to borrow up to 80% of the value of the property.
The HELOC ceiling here would be at $400,000, meaning you could borrow on an investment property using a HELOC and access up to $150,000 as a loan ($400,000 LTV ceiling minus current equity). A HELOC could be issued in this scenario, which would give an investor access to capital.
There are a number of factors to consider when using a HELOC for a rental property, particularly the interest rate and fees.
HELOC interest rates: These tend to be lower than traditional consumer lines of credit due to the security behind the loan -- the property. HELOC interest rates can vary greatly, the typical range is between 3-6%. According to Bankrate, the average HELOC rate as of December 2020 was 4.53%. One downside to HELOCs is the variable interest rates, versus a fixed rate typically seen on home equity loans. This can cause variability -- to the upside or down -- on repayment amounts.
HELOC fees: As with any lending product, there are fees associated with getting a HELOC on an investment property. These can include annual fees, closing costs, application fees, and so on. Generally, these can be taken from the HELOC itself so you aren’t out of pocket initially, but in the end, they will still require repayment.
Can you get a HELOC on a rental property?
Yes. Most lenders will give a HELOC on a rental property as long as the minimum equity requirements are met. For instance, if you have less than 20% equity in the property, then it will be difficult to obtain a HELOC no matter the usage of the property. Because this is a rental property and not a primary residence, the bank will have additional requirements to ensure risk is minimized.
Most lenders also require a higher credit score (720 minimum) for HELOCs on investment property. There will also need to be tenants and leases in place, sufficient cash flow from rental income, as well as some form of cash reserve.
Typically, because investors have to put down 20% or more on investment properties, this equity threshold is met and you simply have to adhere to the requirements of the lender.
The most common uses for an investment property HELOC are for renovations, high-interest debt consolidation, or new acquisitions. Instead of a refinance loan or selling a property, investors will oftentimes explore the HELOC option because it’s less burdensome in terms of paperwork.
HELOCs are also similar to home equity loans, except for a few key differences:
- HELOCs typically have variable interest rates, versus fixed for home equity loans.
- A home equity loan gives you a lump sum with a monthly payment, whereas a HELOC can be drawn as needed.
- Repayment can be interest-only for HELOCs, whereas for a home equity loan it’s a set amount over a given period of time.
Refinance versus home equity loan versus HELOC: Simply put, a refinance loan gives you a lump sum with a new mortgage and terms, a home equity loan gives you a lump sum with monthly repayment terms, and a HELOC gives you access to a lump sum with various interest and principal repayment options.