Need a home equity line of credit on an income property? Here is how to get a HELOC on a rental property.
How to Get a HELOC on a Rental Property
If you’ve landed on this page, you probably know it isn’t very easy to get HELOC on rental property. We know what you’re thinking! While it was easy to get home equity loans, whether you occupy your property or not a few years ago, that’s not the case anymore.
The reason is simple. While more and more people are trying to make money with real estate, the risk factor in a home equity line of credit (HELOC) has increased.
In case of a rental property, the owner can face financial issues, or get in trouble with the tenant, in turn, defaulting on the equity loan.
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Here’s your ultimate guide to getting a HELOC on a rental property.
What is HELOC?
Before we get started on how to qualify and apply for a HELOC loan on your rental property, you need to be clear about the term. HELOC is different from basic home equity loans.
The latter is a second mortgage that you can receive depending on the home equity value of your property. It’s dispatched in a single sum of money that you can borrow and use as you wish.
HELOC is almost like home equity loans but differs in one aspect. Here, you have a certain limit to the amount you can access. You will get the credentials to an account, from which you can withdraw the amount you need for your home.
Simply, in this case, you only have to return the amount you’ve borrowed instead of the whole lump sum.
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How is HELOC for Rental Properties Different From Owner Occupied Properties?
A rental property is a great way to generate a steady income in real estate. That’s why, if you can get a HELOC to make improvements and upgrade your rental property regularly, it’s like a full-proof formula to increase the value and benefit from your investment in real estate.
However, when it comes to getting HELOC for your rental property, things might get tricky. That’s because, in the case of a rental property, the lender is always at risk.
An owner is more likely to become a defaulter on a property he has not occupied, than on the one that he has.
Similarly, HELOC lenders are usually the third or second in line for possession of the property. This means in case the owner becomes bankrupt, the lenders are less likely to recover the funds they lent.
Furthermore, if you’re planning to take on HELOC on your rental property, you should keep in mind that the interest rates will be higher for you.
Also, you will need more than one appraisal for qualification. Wait, there’s more, upon qualification, you’ll have to wait for at least a year-long waiting period before you can get the first installment.
With all these restrictions and constraints, is it worth getting a HELOC for your rental property?
Here are the basic benefits that are sure to lure you into giving it a try.
Why Should You Get a Home Equity Line of Credit?
There must be some readers out there thinking, why should you get a home equity loan on your property. Well, there are many benefits of a home equity line of credit with a rental property.
First of all, you can use the line of credit to finance home improvements or renovate your property completely.
In the case of rental properties, this can help you increase the value you put on your property and also diversify the facilities to attract more tenants.
Secondly, compared to credit cards and other bank loans, a home equity line of credit has much lower interest rates. Besides that, it has a lower initial cost as well, which means more benefit at a minimal investment.
Thirdly, according to the Tax Cuts and Jobs Act 2017, your home equity interest amount can be deducted from the taxation. The latest reform in the law establishes that you can deduct the home equity amount if you’ve used it on home improvement.
Lastly, with HELOC, you can specify the amount you borrow according to your current needs.
Also, you can choose your own repayment methods with HELOC.
It’s flexible enough to let you pay back interest only in the first few years, and you can extend the period up to 30 years.
Most importantly, if you’re a risk-taking investor, you can diversify your investment portfolio, and use the equity you get on your rental property to buy another property. In short, getting HELOC helps you make more money in real estate.
If you use real estate crowdfunding, you might not have to worry about a home equity line of credit.
If you think the benefits are worth the toil, here’s how you can get HELOC on your rental property.
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Getting HELOC On Rental Property – A Step-by-Step Guide
If you file for HELOC for a rental property, lenders tend to scrutinize your application owing to the potential risks involved. Make sure you have the following aspects cleared to qualify for HELOC on rental property.
Render Your DTI To An Acceptable Range
Let’s face it, the only thing lenders are concerned about is whether they’ll get their money back or not. That’s why, before lending out their funds, the first thing they’ll assess thoroughly is your DTI. This means your debt to income ratio.
When it comes to your DTI, there are two sides to this coin. The front-end debt report includes all of your housing expenses, insurance, interest payments, and taxes.
Besides that, the back-end report includes all of your currently payable debts that show on your credit reports.
The lender’s topmost concern for your lenders will be your back-end report. Each bank and organization has the respective thresholds that they deem acceptable.
Look these clauses up close before you apply.
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Determine LTV And HCLTV Beforehand
You need to remember that all decisions regarding your HELOC will be conducted, keeping the entire credit line in mind. Not just the initial withdrawal. This means for any loan approval, your loan to value ratio will be determined according to a certain percentage limit set by the organization.
Usually, in the case of HELOC, CLTV, the current value of all loans is divided by the value of the house.
Choose a lender who has the minimum threshold of your approximate loan to value amount.
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Build a Favorable Credit Profile
Your credit report should be crystal clear if you expect a lender to accept your application. A flawless credit report free from degrading aspects such as tax lien, bankruptcy, and foreclosure has higher chances of qualifying for HELOC.
That doesn’t mean you should use dishonest measures to clear the clutter on your credit report. Remember, lenders know when there’s something fishy. If you hide any facts or figures, they’re likely to find out.
Just make sure all the information is correct and accurate before you turn it in.
Save Some Cash
Most lenders have mandatory requirements for initial cash reserves before parting with their funds. You should have enough cash in-store to certify that you can pay back the funds you borrow, at least for a few months.
The time duration varies from one to two years. Also, some lenders need certification that you can afford to pay the entire line of credit you receive.
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What if I Don’t Qualify For HELOC On Rental Property?
Yes, it’s quite difficult to get HELOC on a rental property. Even if there’s one glitch in your record, you can have a hard time getting accepted.
Luckily, there are a few other options you can go for if that’s the situation for you.
File for a Personal Loan
While you might not get the benefit of lower interest rates when filing for a personal loan, it remains a reliable option. That’s because you don’t need any collateral, such as your house or investment property, to receive the loan against.
Also, it’s much less of a hassle as well.
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Go for Cash-Out Refinancing
If you already have a mortgage amount against your property, cash-out financing is another option for you. Through this, you can renew your mortgage and refinance it for a higher sum than before.
This way, you can receive the difference between the original and the current amount. However, you will need a conventional loan to file for refinancing.
Besides that, you’ll need to check if your particular mortgage loan qualifies for the same.
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Although cross-collateralization can be expensive to manage when it comes to separating interest and proportioning the debts, it’s a unique and new alternative to HELOC. You can make a cluster of more than one property and group them under the same loan.
Now, you can access the equity in your rental property easily as it’s combined with the equity of multiple properties.
See Related: Pros and Cons of Real Estate Investing
Most of the criteria for a HELOC is similar to a conventional mortgage loan. All you need to have is a reliable credit history and enough stable income to support your loan amount. Even though getting a HELOC on a rental property is more difficult than getting one on an owner-occupied property, it’s worth a try.
Make sure you check the credibility of the lender as well and on the other aspects involved before signing up for a HELOC on your investment property.
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