Can I Take Out a HELOC on Rental Property?
The short answer to this question is yes – you can indeed take out a HELOC on rental property. However, it isn’t as simple as this. A HELOC, also known as a home equity line of credit, was initially designed for owner-occupied homes, also known as a primary place of residence. This means that when they first came out, this was all that they were used for. People couldn’t take out a HELOC on a rental property. Why? Because the risk factors are higher when there are loans on property that you don’t live in. Here’s what you need to know.
HELOC On Rental Property
The number one issue that you’ll have when trying to take out a HELOC on a rental property is finding a lender who offers this type of loan. While many traditional lenders, especially those who do mortgage loans, offer HELOCs in general, many reserves that right for primary residences only. Allowing people to take out a HELOC on a rental property is just too risky. Why? If something should happen to your finances, causing a downturn, then your priority is to pay off the mortgage and HELOC on your own house. The rental property falls by the wayside. In addition, if you need to file for bankruptcy, then the first things that would disappear are those rental properties. They become assets that are sold. Now, you no longer own the houses, and the HELOC is just another debt to be settled – and it would be paid only after the initial mortgages are. This makes it less likely that the HELOC will be paid in full.
There’s a reason why many banks and other lenders raise the rates on the mortgages for investment properties. The situation is riskier. With a HELOC, you’ll run into the same issue. If the lender offers this type of loan and is willing to give one to you, then you’ll pay a larger sum of interest on it. You’ll also need to take out a smaller loan since the equity ratio that many lenders are willing to work with is much different when it comes to rental properties. This means that you’ll have to settle for something smaller if you can take out the HELOC at all.
Other Factors Involved
If you do manage to find a lender willing to offer a HELOC on a rental property, then you need to go through the same hurdles that you would for a standard loan on your primary residence, with a few additional requirements added on. First, the lender will need to look at your credit score, as well as your debt to income ratio. These are pretty standard. You’ll need to have a credit score of at least 680 (which is on the low side of “decent”), as well as a debt to income ratio of between 40 to 45%. Although, since the loan is riskier, you might need a higher credit score and lower debt to income ratio before they even consider going through the next steps of the process. This is entirely up to the lender, just be aware that this could happen.
The next steps involve examining the rental property and your ownership of it. Not only do you need to have some equity available in the property (this is the amount that is left over when the house’s worth is subtracted from the mortgage loan, for the record), but you also need to have owned that property for at least one year. You also need to have a lease in place to show that the home will be occupied in the near future. The longer the lease the better, and if the tenant has lived there for years, then this is the best. It shows that you’ll have income on the house, and will be less likely to file for bankruptcy.
On top of this, you’ll also need to prove that you have a very long track record of successful property investments in the area. Basically, the more investment properties that you own outright – and don’t have mortgages on – the better you’ll look in the eyes of the lender. Your track record matters. Plus, you’ll need to prove that you have a very large amount of money in the bank. These liquid assets are important, as they show that you’ll be able to pay off the HELOC should you run into financial issues. The exact amount that’s required isn’t static, and it depends on the lender.
Overall, if you can’t take out a HELOC on a rental property for whatever reason, there are some alternatives, such as personal loans and even second mortgages. With that said, a HELOC is still a valid option, as long as you meet all of the requirements.