Savvy consumers ask me all the time if it is risky to take out a home equity loan to invest in real estate or a new business. Purchasing investment properties can be an outstanding way to create passive income and diversify your investments. However, purchasing rental properties takes a lot of money. If you don’t have that much money in your savings account, what should you do?
Is It Smart to Take Out an Equity Loan or HELOC for Investment Purposes?
Many aspiring investors decide to use some of their home equity to buy real estate.
A home equity line of credit (HELOC) or home equity loan allows you to use some of the equity in a property for cash for any purpose.
Many investors like to get a HELOC or home equity loan from their personal residence to invest in real estate.
Learn all about a HELOC for investing below. If you need more information about home equity loans for investments or HELOCs for investing,
Home Equity Mart can help you locate competitive lenders and banks that specialize in home equity loans and HELOCs to buy investment properties and real estate.
Why Use Home Equity to Buy Real Estate?
Home equity has been growing substantially for millions of American homeowners in the early 2020s. Instead of waiting to enjoy your profits when the home is sold, it may be smart financially to pull out equity with a home equity loan or HELOC and invest in real estate. Using your equity to invest in real estate can lead to great increases in your wealth. Instead of using equity to renovate your home or pay off debt, you could use it to create passive cash flow.
You may want to use a HELOC to invest in real estate if you prefer a variable interest rate loan. A HELOC’s rate may be fixed initially and has interest-only payments during the five or 10-year draw period. After that, interest and principal are paid back. It is a line of credit that works similar to a credit card, but the credit line is based on the equity in your home.
On the other hand, a home equity loan is a fixed-rate loan with a fixed payment. It gives you a lump of cash to invest in real estate or whatever you wish, and you pay interest and principal on the full amount from day one.
Pros and Cons of Buying Investment Property with Home Equity
It can be a wise financial choice to buy real estate with home equity, whether you use a home equity loan or HELOC. However, there are many considerations you need to think about before tapping your equity and applying for a loan:
Pros
- You get low-interest cash to buy investment properties. Interest rates are still high in 2024, and borrowing money is more expensive than three years ago. However, a HELOC or home equity loan may carry an 8% or 9% rate, depending on market conditions and your credit. This is still relatively inexpensive money to borrow.
- You can use cheap money from your equity to cover down payments for investment properties or buy them outright.
- You leverage your equity to grow wealth. Home equity is good, but it is just sitting in your home until you sell it. You can use that money to purchase properties that may generate rental income and increase in value.
- You can get low-interest money to pay for rehabbing the properties that you purchase. You then can either flip the houses or rent them out for cash flow.
- Many Americans become independently wealthy by investing in real estate. If you do it correctly with home equity, you can greatly increase your net worth and maybe even retire early.
Cons
- You are taking on debt. Home equity is an asset, even though it is not liquid. A HELOC for investing or home equity loan for investing allows you to use your equity, but you must pay interest to do so.
- The housing market can change. Real estate markets go up and down, and this can affect your home value. Some homeowners end up owing more than their home is worth. If your real estate investments lose value, the problem is compounded.
- If you take equity out of your home, you have another loan to pay. You need to be sure you will have sufficient income to pay the second-mortgage. If you don’t, you could lose your home. If your investments don’t work out, you could wind up having to pay for the second mortgage out of your regular income or savings.
- Investment properties don’t always work out. If you tap equity to buy rental properties, you could have problems with tenants and more vacancies than you thought. If you flip, rehabs may cost more than you expected and the home may not sell quickly or for the price you anticipated. Do your due diligence on any home you want to invest in and make sure you have plenty of reserves built in.
How to Use Home Equity to Buy Investment Property
Using your home equity to purchase an investment property can be a strategic financial move. Home equity is the difference between the current market value of your home and the amount you owe on your mortgage. Leveraging this equity offers access to funds that can be used as a down payment or even cover the entire cost of a new investment property. However, this approach requires careful planning and knowledge of various financing options, such as home equity loans and home equity lines of credit.
Understand Home Equity Loan Options
There are two main ways to use home equity: a home equity loan or a HELOC.
- A home equity loan provides a lump sum upfront and has fixed monthly payments over a set period, making it ideal for buyers who want predictable payments.
- A HELOC functions like a credit card, allowing you to withdraw funds as needed during the draw period. It offers flexibility, especially for investors seeking quick access to capital for multiple purchases or renovations.
Both options use your home as collateral, so it’s important to assess your financial stability before moving forward.
Calculate Your Available Equity
Lenders typically allow homeowners to borrow up to 80% of their home’s value, minus the amount still owed on the mortgage. For example, if your home is valued at $400,000 and you owe $200,000, you could potentially access $120,000 ($400,000 × 80% – $200,000). However, the exact amount will depend on your credit score, income, and lender-specific requirements.
Use the Funds as a Down Payment
Many investors use home equity as a down payment for a rental property. This is beneficial since larger down payments often result in better mortgage rates and terms on the investment property. Additionally, real estate investors purchasing a second home or rental property typically need a minimum down payment of 15-25%. Using equity can make this upfront investment more manageable.
Finance Property Renovations and Repairs
Another effective way to leverage home equity is by financing renovations or repairs on the investment property. Improving the property can increase rental income and long-term property value, ensuring a higher return on investment. With a HELOC, investors have ongoing access to funds, making it easy to manage unexpected expenses throughout the project.
How to Qualify for a HELOC or Home Equity Loan for Investing
Getting a HELOC or home equity loan for investing in real estate involves submitting a mortgage application with your lender. You will need to pay closing costs and fees on any loan you get, but the closing costs could be built into the loan. To qualify for either loan, you may need the following qualifications (lending standards vary based on the lender):
- A 640 to 680 minimum credit score. People with higher credit scores get better rates.
- A debt to income ratio no higher than 43% or maybe 45%, depending on the lender.
- At least 20% equity in the home.
- Tax returns, bank statements, and pay stubs to
Are There Closing Costs with Home Equity Loans for Investing?
In most cases there are HELOC closing costs and lending fees on home equity lines of credit and 2nd mortgages. These are higher risk loans and when someone borrowers money for an investment it increases the risk substantially.
Summary on Investing with HELOCs and Home Equity Loans
Buying investment properties is often a good decision. You can grow wealth if you buy the correct properties at the right price and all goes well. Tapping equity to buy investment properties can be a low-interest way to leverage your cash and increase your net worth.
However, investing in real estate with your home equity is perilous and things can go wrong, so make sure you do all due diligence on the homes you buy.
While using home equity can unlock financial opportunities, there are risks. If the investment property does not generate expected returns or if there are unexpected market downturns, you could face difficulty repaying the loan. In worst-case scenarios, failure to repay could put your primary residence at risk of foreclosure. Therefore, it’s essential to develop a solid repayment strategy and have contingency plans in place.
Using home equity to buy investment property is a powerful tool for expanding your real estate portfolio. With the right planning, a home equity loan or HELOC can offer access to capital for down payments, renovations, or even the full purchase price of a property. However, investors must carefully evaluate the risks, consider market conditions, and ensure they have a viable repayment strategy to protect their financial well-being.
If you are a new investor, lean on an experienced investor to ensure that your investments are successful. If you are ready to apply for a HELOC or home equity loan for investing, our team at HomeEquityMart.com can advise you.
References:
Consumer Financial Protection Bureau. (n.d.). Considering a Home Equity Loan or Line of Credit? https://www.consumerfinance.gov
RefiGuide.org Can you Use a HELOC to Buy a House?