Saving for the down payment can be one of the most difficult parts of buying an investment property. If you’re a homeowner, your home equity could help finance your real estate investment. Before taking on additional debt, it’s important to understand the rules governing this type of loan and your potential tax liability.
Accessing Your Home’s Equity
Part of your home’s equity is the amount you’ve paid off on your mortgage principal compared to the amount you still owe. Another factor is how much the value of your home has gone up or down since you purchased it. Once you determine how much equity you have in your home, you can look into accessing it with a second mortgage, also called a home equity loan. Another loan option is a home equity line of credit (HELOC). The main different between a home equity loan and a HELOC is that the equity loan is delivered in a lump sum, while the HELOC is an account that you can access on an as-needed basis. Another difference is that many HELOCs come with a variable interest rate that may be less desirable than the low fixed rates available with equity loans.
Investing With an Equity Loan
Your home equity can be a financial safety net in case of job loss or a medical emergency. If you have an emergency fund then you may want to use your equity for investment. Real estate can be a sound investment for an equity loan, especially if it provides rental income that covers the loan payments. Before taking on additional debt, make sure you understand the risk involved. Missing payments on your home equity loan puts you at risk of losing both your primary home and your investment property. If you’ve analyzed the risk and decide to proceed, using a home equity loan to finance the down payment or the entire purchase price is no different than using any other source of money to buy real estate.
Tax Deductions for Home Equity Loans
You may be able to deduct the interest you pay on a home equity loan on your federal income tax. The Tax Cuts and Jobs Act of 2017 changed the deductions homeowners can take for interest paid on home equity loans and lines of credit, but loans used to buy a home may still be eligible. Starting in 2018, homeowners can deduct interest on $750,000 in qualified home loans. This limit applies to the combined mortgages and loans used to purchase or improve a first and second home.
- Federal Trade Commission: Home Equity Loans and Credit Lines
- IRS: Interest on Home Equity Loans Often Still Deductible Under New Law
- Trulia: What Is Home Equity?
- Nolo: When Home Equity Loans or Lines of Credit Can Lead to Trouble
- Lendedu: Can You Use a Home Equity Loan or Line of Credit on an Investment Property?
Catie Watson spent three decades in the corporate world before becoming a freelance writer. She has an English degree from UC Berkeley and specializes in topics related to personal finance, careers and business.