Your rental property needs some major repairs, and you’re short on cash. Home equity loans are a good source of income when you need it, but can you receive a home equity loan on a rental property? While it is more difficult to qualify for a home equity loan on a rental or investment property than it is on your primary residence, it is possible. Even obtaining a home equity loan on a vacation house is more difficult than getting one on your main dwelling.
Non-Owner Occupied Home Equity Line of Credit
A home equity loan allows you to borrow against the equity in the property. Not every lender offers home equity loans on non-owner occupied properties. That’s because a home equity line of credit on an investment property is far riskier than the same loan on a principal residence. If an investor loses their tenant or experiences other financial issues, they may default on a home equity loan on a rental property, while owners are far less likely to default on a home equity loan and potentially lose the roof over their heads.
Should the investor declare bankruptcy, the lender holding the initial mortgage on their residence is first in line to receive payments from assets sold to relieve debts. It’s likely that there isn’t enough money available to pay off a home equity loan on the primary residence, let alone a home equity loan on a rental property.
Stringent Loan Qualifications
If you can find a lender willing to give you a home equity loan on a rental house, prepare yourself for far more stringent qualifications than are warranted for a personal home equity loan. Such qualifications may include:
- Owning the property for at least one year
- Tenant in residence with a lease
- High credit score
- Substantial cash savings in the bank
There’s another caveat. If this is the first and only rental property you own, it’s unlikely a lender will consider a home equity loan. The risk is just too great. On the other hand, if you have a strong history of successful rental property investment, the lender considers you a much better candidate for a home equity loan.
Home Equity Loan Rates
If a lender approves a home equity loan on your rental property, expect to pay a higher loan rate than on a principal residence. The home equity loan rate isn’t the only higher item. When you open a home equity line of credit on a primary dwelling, the lender may waive certain fees, such as:
- Title search
When the home equity loan is for a rental property, you’re on the hook for all of these closing costs. Since lenders for home equity loans on rental properties may require a higher minimum loan amount than for a home equity loan on a personal residence, prepare yourself to borrow more money than actually required for this type of loan.
If you qualify for a non-owner occupied home equity line of credit, you cannot borrow as much as you might from a home equity loan on your own residence. The loan-to-value ratio (LTV) is much lower for rental properties than owner-occupied residences.
Getting Your Paperwork in Order
Before seeking a home equity loan for a rental property, get your finances and paperwork in order. For the former, try to save between 18 months and two years’ worth of your estimated home equity loan payments.
Check out your credit report. The three major credit reporting agencies – Equifax, Experian and TransUnion – each allow you to receive an annual copy of your credit report. Review the reports for accuracy, and if you find errors, correct them as soon as possible.
If your credit score is low, work on repairing it before applying for a home equity loan on your rental property. That means paying off other debts, such as credit card bills, and ensuring all of your bills are paid on time.
If you don’t have enough equity in your investment property to qualify for a home equity loan, build up that equity by making extra principal payments on your mortgage. Even a hundred dollars per month can add up, and it’s a good idea to put any extra money you have toward that purpose.
No Deductions for These Loans
Prior to the passage of the Tax Cuts and Jobs Act signed into law by President Donald J. Trump on Dec. 22, 2017, homeowners could deduct their home equity loan interest no matter the purpose of the loan. As of 2018, however, homeowners can only deduct the interest on home equity loans if the funds were used to make improvements on their residence.
Due to the tax law changes, it is no longer possible to deduct interest on home equity loans taken out on investment properties, even if the money is used to improve the dwelling. That makes the home equity loan a less attractive option for such purposes than it was in the past. However, even without interest deductibility, home equity loan rates are generally lower than other types of loans.
HELOC Alternatives on Rental Properties
If you can’t find a lender offering a home equity loan on a rental property, or you don’t qualify for such a loan, all is not lost. There are alternatives for obtaining the cash you need, although you may pay higher interest rates. You might consider taking out a personal loan, which does not depend on using collateral such as your home or investment property. Before applying for a personal loan from your banker or other lending institution, make sure you have a healthy credit score and that your debt-to-income ratio is well-balanced.
Cash-out refinancing is another option if you have a mortgage on your rental property and you’ve built up significant equity. A cash-out refinance permits you to refinance your mortgage at a higher amount. You then receive the cash difference between your former and current loan. A conventional loan is required for a cash-out refinance on your investment property. Loans obtained from the VA, FHA and similar programs do not generally qualify, according to The Mortgage Reports.
LTV regulations are set by Freddie Mac and Fannie Mae, the government-sponsored enterprises created by Congress to provide mortgage market liquidity. Most lenders will follow the LTV leads of these mortgage industry giants, which as of 2019 permit an LTV of 75 percent for fixed-rate mortgages. If your rental property has been on the market, you must take it off, and any property that has been for sale for the prior six months qualifies for LTV of 70 percent for fixed-rate mortgages. If you want to go the adjustable rate mortgage (ARM) route, your LTV percentage may prove lower.
As a last resort, you might consider using credit cards for your loan needs. Avoid using a credit card if you need to borrow a great deal of money since credit cards interest rates are much higher than other types of loans. Shop around for a low-interest credit card meeting your needs.
- Lending Tree: Can You Get a Home Equity Line of Credit on an Investment Property?
- Value Penguin: HELOC on Rental Property: Investing and Applying
- Lend EDU: Can You Use a Home Equity Loan or Line of Credit on an Investment Property?
- The Mortgage Reports: Do a Cash-Out Refinance on Your Rental Property: 2019 Guidelines and Mortgage Rates
- Look at multiple lenders to see which is able to provide you the best rate.
- Consider your intentions for the home when you are choosing your loan type. Unless you are planning on selling the property in the near future, a fixed rate loan is generally more cost effective.
A graduate of New York University, Jane Meggitt's work has appeared in dozens of publications, including PocketSense, Financial Advisor, Sapling, nj.com and The Nest.