SHOULD I DO A LINE OF CREDIT ON MY RENTAL?

Question

Hi all, newbie here with a question. I took a HELOC on my primary residence that went towards purchasing my first rental. I'm renting it out for $1400 and my mortgage is $836. From that cashflow $215 is used to pay the HELOC loan. The rental has about 40-50K equity (i closed on it end of January 2022). Should i pull out some of that equity to put towards the next investment property or am i leveraging myself too much? What are your thoughts?

TIA

Justin Konz · Answer

@Michael Cortez A lot of people have different comfort zones when it comes to leverage, especially leveraging your primary home for an investment. Ultimately, it comes down to your comfort zone.

Couple things to keep in mind: 1) getting a line of credit on a rental property can be very difficult. I had to go through a dozen banks before I found one willing to offer that product and even then I had to pay commercial rates/fees 2) Unless you need it for the down payment on your next property, I would try to obtain longer-term 30-year rental financing. The reason being is that banks can call lines of credit due at any time (not renew the line). In another words, when you most need it is when banks will most likely cancel it (loss of employment, market crash, etc).

Hope that helps, let me know if I can be of further assistance.

Steven Goldman · Answer

Mike, here is a good article about investment property HELOCS.

What it Takes to Access an Investment Property HELOC

A borrower requesting an investment property HELOC by a lender needs to get their financial ducks in a row. Due to the risks involved, lenders are naturally cautious when considering a rental property line of credit. There is a lot at stake from a lender’s perspective, so expect to be prepared in all ways possible. For starters, a borrower must have excellent credit scores, ample cash reserves, and have owned the investment property for at least one year.

The lender will likely want proof of solid tenants that make timely and consistent rent payments, and proof of a lease agreement. Not only will the current investment property scenario be carefully examined, but the borrower’s entire history as a real estate investor will be scrutinized before a lender grants a rental property line of credit.

The fact that an investment property HELOC allows repeated access to credit, makes it a stellar option for an investor intent on returning the credit availability to its original set point. To have such a flexible and open line of credit makes the investment property HELOC such a desirable financial tool for a rental property investor.

Benefits and Risks of a Rental Property HELOC

Why are lenders so reluctant to approve a HELOC for an investment property? Say the borrower loses his tenants at the same time he finds himself unemployed – a not altogether unrealistic scenario by any means. Life happens, and for a property investor that leaned on their home to grow their portfolio, things can get serious fast.

For a borrower’s first priority in such a situation will be to protect his own home, not their investment properties. If the borrower struggles long enough and ends up losing their home in foreclosure, assets sold to pay off debts will not necessarily leave enough money to settle the second or third loan. That means the HELOC may very well never be repaid, leaving the lender empty handed.

As a result, lenders build in protections equal to the risks. For one, an investment property HELOC comes with a higher interest rate than one written for a primary residence.

A HELOC on a primary residence could have a loan to value (LTV) ratio of 90%. Not so for a rental property, with stricter loan terms meaning the LTV may only reach from 75% to 80%. And one last big difference with an investment property HELOC is that the lender reserves the right to ask for two home appraisals, whereas one will suffice for a homeowner HELOC. Again, all these things are in place to protect the lender, due to the raised risks involved in granting a rental property HELOC.

While borrowers applying for a HELOC on their primary home can often get approved with FICO scores at or above 660, those looking for a HELOC drawn on an investment property should shoot for a score north of 700.  Check with figure to discuss the credit score needed to get approved for a HELOC on an investment property.

A huge plus in using an investment property HELOC is in the way an investor can draw the down payment for a desired property, and pay it back, leaving the available credit still intact for later use. As long as you continue to pay back the borrowed down payment, a replenished account means you can reuse the open credit for future down payments – over and over and over again.  Needless to say, this leaves an incredible potential to swiftly grow your portfolio.

Good luck.

Steven Goldman · Answer

Mike I got it. A local bank or a credit union would be the place to go. I would check into it before I made to many plans. It is still a investment property regardless of how you take title.

Steven Goldman · Answer

Hi Michael, I would cash out refinance your rental property use some of the money to pay off your HELOC and use your HELOC to buy another rental property. Lines of credit in the commercial real estate lending space are rare. Their are a few local credit unions who might do a line of credit on a investment property but the  majority of lenders will not. Good luck.