Using A Home Equity Loan On An Investment Property: A Guide

5 Min Read

Updated July 16, 2024

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Written By

Victoria Araj

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You can use different financing strategies to buy an investment property. One popular option is to tap into your home’s equity with a home equity loan to purchase an investment property.

However, using a home equity loan to purchase an investment property has some risks. We’ll outline the steps to apply for a home equity loan and highlight the risks associated with using a home equity loan to build your real estate investment portfolio.

Home Equity Loan Overview

A home equity loan allows homeowners to access cash by tapping into the equity in their home. You receive a one-time lump-sum payment from your lender and repay the loan in monthly installments. A home equity line of credit works differently. Like a credit card, a HELOC is a line of credit that lets you access funds on demand that you repay as you borrow.

Borrowers can use the funds from a home equity loan for nearly any purpose. They receive a fixed interest rate on their loan, so their monthly payments stay the same each month – making it easier to budget for loan repayment.

What’s Your Goal?

Home Purchase

Home Refinance

Tap Into Equity

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 you should understand the risks involved. And there’s a real risk of losing your primary residence if you default on the loan.

Get matched with a lender that can help you reach your financial goals.

Requirements For A Home Equity Loan To Buy A Rental Property

You must meet the following requirements to take out a home equity loan to purchase an investment property:

Credit score: Lenders require a credit score of at least 680 or higher to qualify for a home equity loan.
Loan-to-value ratio: Lenders typically require a loan-to-value ratio of 80% – sometimes 90% – to qualify for a home equity loan.
Debt-to-income ratio: Lenders may accept a maximum debt-to-income ratio of 50%.

Find a refinance lender that will work with your unique financial situation.

The Pros And Cons Of Using A Home Equity Loan On A Rental Property

Using a home equity loan to purchase an investment property has advantages and disadvantages. Here are a few things you should consider before taking out a home equity loan:

Pros

Buying an investment property is a good way to earn passive income.
Home equity loans have lower interest rates than most other types of loans.
You’ll receive a fixed interest rate on the loan.
Each month, you make the same loan payment, making it easier to budget for the loan.

Cons

You’ll put your primary residence at risk if you default on the loan.
A decrease in your home’s value can limit your desired loan amount.
There’s no guarantee you’ll see a return on your investment.
Home equity loans require closing costs.

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 Your Credit Score

You’ll need a good credit score to take out a home equity loan, so review your score before applying. You should also check your credit history. Request a free copy of your credit report from AnnualCreditReport.com to check for any errors that may be hurting your credit score.

If your credit score is lower than you would like, you can take steps to improve your credit score or recruit a co-signer to apply for the home equity loan with you and improve your chances of approval.

2. Get Financial Documents

Next, you’ll need to gather the financial documents your lender requires to verify your identity, such as a government-issued ID and Social Security number. You’ll also need to provide your address and birthdate.

Your lender will also require proof of a recurring source of income, so you’ll need to 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 review offers, note which lenders offer low interest rates and flexible repayment terms. And watch out for additional fees that may drive up the total cost of the loan.

FAQs: Home Equity Loans And Investment Properties

If you have additional questions about taking out a home equity loan to expand your real estate portfolio, check out our answers to these frequently asked questions.

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 savvy way to diversify your investments and create a source of passive income. But make sure you feel confident about your ability to afford the monthly payments to avoid putting your primary residence at risk.

Is a HELOC better to use than a home equity loan?

Whether you should take out a HELOC or home equity loan will depend on the situation. A home equity loan offers fixed interest rates and is typically better for a significant, one-time expense. A HELOC is generally a better option for ongoing expenses or projects with uncertain total costs, like home improvements.

Is a home equity loan tax-deductible?

The interest on a home equity loan may be tax-deductible when you use the loan to buy or improve a primary residence. However, the interest isn’t tax-deductible if you use the funds to buy an investment property. Be sure to consult a tax professional regarding your eligibility.

What are alternatives to a home equity loan for funding a rental property?

Common alternatives to a home equity loan or HELOC to fund a rental property purchase include:

Cash-out refinances: With a cash-out refinance, you can replace your original mortgage with a new, larger mortgage and receive the difference in cash. You can use the money as a down payment on a rental property.
Personal loans: Using a personal loan gives borrowers more flexibility around their use of the funds. You can use the lump-sum payment to cover the cost of repairs, renovations or unexpected expenses.

The Bottom Line

While you can use a home equity loan to buy an investment property, don’t forget to consider the risks involved or compare the loan to other options such as a HELOC, cash-out refinance or personal loan. Don’t take the first offer you get from a lender. Compare lenders to determine which offer aligns best with your investment goals.