Can you get a HELOC on an investment property?

When you’re ready to officially apply for a HELOC, be prepared for the kind of complete under-the-hood type of financial scrutiny you would receive with any type of request to borrow a sizable chunk of money. A lender will look at your credit score, your debt load, your cash flow, your cash reserves and every other detail about your finances to determine a) whether they will loan you the cash and b) how much they’ll charge you to borrow it. The lender will also probably do an appraisal of your property, which sets the official value on it. In determining its worth, they’ll look at its condition and also the amount and sort of income it generates.

Closing on a HELOC is typically a much faster process than closing on a traditional mortgage. Some lenders – particularly the online institutions — promise to process your application in as little as three days, and (assuming approval) you can access the cash within a week. However,  the timeline varies based on the lender and your particular circumstances. In some cases, closing could take as long as a month to six weeks.

Even if it’s residential, an investment property is different from a second home. Basically, a second home is a property you purchase for personal use, either for vacation or to live there at least part-time. An investment property, in contrast, is purchased to generate income (via rents or leases) and/or profits upon sale.  Admittedly, the line can get blurry, if a place serves both purposes — i.e., you sometimes occupy it, and sometimes rent it out. The amount of time you personally use the property determines how it is classified for any sort of loan. IRS rules state you can live in an investment property for up to 14 days or as much as 10 percent of the total number of days that you rent it out.

The criteria for investment property HELOCs tend to be more stringent than those on residences. In addition to the borrower’s creditworthiness, lenders also look at the property’s financials.

• Cheaper than many other forms of borrowing: The interest rates on HELOCs are often lower compared to other forms of financing like credit cards and personal loans. (You’ll likely pay a bit more because the loan’s tied to an investment property, however — more on that below.) A HELOC might also be simpler and cheaper to obtain than a business or commercial property loan.

• Less risk for you: Taking out a HELOC on an investment property might feel a bit safer than a HELOC on your primary residence. If you default on the line of credit, at least the home you live in won’t be subject to foreclosure.

• A flexible way to access cash: You can continually tap the HELOC during the initial draw period, so it’s often a good fit for fluctuating or longer-term expenses like renovation projects.

• Cheap initial payments: With most HELOCs, you only need to pay interest during the draw period. Paying back the principal starts during the repayment period.

• Limited availability: Not many lenders offer HELOCs on investment properties.

• Higher rates: An investment property is inherently riskier than a primary residence: You don’t live in it, which means you aren’t as impacted if you lose it. That means that lenders charge higher rates for any type of financing attached to one, including a HELOC. For example, TD Bank’s lowest available APR on HELOCs for investment properties is currently 2 percentage points higher than a HELOC on a primary or secondary home.

• Extra fees: Most HELOCs come with an annual fee and an early cancellation or termination fee if you close the line within the first two or three years.

• Negative equity concerns: Real estate doesn’t always appreciate, and if your property loses value, you could wind up underwater (owing more on a property than it’s worth).

Using a HELOC on an investment property can be an easy way to access cash that will generate a return.  For example, you might use the funds from the HELOC to buy another property that can act as an additional investment, without depleting your savings. Or you might use the funds to upgrade or expand your property, making it more attractive to prospective tenants and enhancing its revenue stream. HELOCs are an especially good idea when you want to use the funds on the real estate itself — because there are tax benefits (see FAQ below).

• Cash-out refinance: With a cash-out refinance, you’ll refinance the loan on your investment property to a higher amount — provided you have enough equity — and take the difference in cash. Some savvy real estate investors use this method to continuously add new properties to their portfolio mix. However, this strategy might not work as well today, with mortgage interest rates having gone up.

• HELOC on your home: If you can’t find a lender willing to extend a line of credit on your investment property, you might want to consider taking out a HELOC on your primary residence. This means your home is on the line, however, if you can’t repay what you borrow. You might not be able to get as sizable a loan, and if you use the funds on the investment property you won’t be able to deduct any interest (the tax break only works if the money is spent on the collateralized property).

• Personal loan: Depending on your debt load, you might be able to take out an unsecured personal loan as a lump sum. The interest rates on these can be much higher if your credit isn’t the best, however, and you’ll need to start repaying what you borrowed right away.

• Small business loan: If you have set up a company to own/operate your investment property, consider small business loans or lines of credit to access the funds you need. The interest rates on these loans will likely be higher than that of a personal HELOC, and you’ll have to start full repayments right away or make more frequent payments (in the case of the line of credit). But if you have a solid business plan you can show to a lender that documents your strategy for expanding your real estate investment portfolio, this can be another viable option.

Opening a HELOC on an investment property can be a savvy financial move, particularly if your need for the funds is real estate–related. You can leverage the property to improve the property — and its income-generating or appreciation potential. Plus, you may be able to score some tax benefits.

However, a HELOC on an investment property isn’t all upside. The few lenders who offer them generally view investment properties as riskier than primary residences: They are in effect mini-businesses, with their profitability related to the rental income they generate. There’s also the likelihood of a borrower prioritizing payments for a primary residence in times of financial trouble. As a result, rates are higher than some other types of financing — including residential-property HELOCs — and you need to have pretty solid financials.

• How do you find banks that offer HELOCs on investment properties?

  While it can be somewhat harder to find lenders that offer HELOCs for investment properties, it is possible. The key is shopping around and investigating several lenders, reading the fine print on their lending policies (most will specify at some point the sort of properties they’ll finance). Be sure to consider online and brick-and-mortar lenders, both national and local; see if any specialize in a small business owner clientele. And don’t overlook mortgage brokers: Some may also specialize in HELOCs for investment properties.

• Are you able to deduct a HELOC on your taxes?

  Tax advantages are one of the pluses of HELOCs. You might be able to deduct the interest paid on a HELOC, including a HELOC on an investment property, so long as the funds were used to build, improve or repair the real estate backing the loan in some way. You can’t deduct all of the interest, however. You can only deduct the interest actually accrued on withdrawn funds (not on your total line of credit).

• Can you use a HELOC for a down payment on an investment property?

  HELOC funds can be used for pretty much anything. This includes down payments on other properties. Using a HELOC from a current investment property to purchase a second property could be a smart way to leverage your assets, increasing your income while not impeding your cash flow. But read the fine print from your lender to make sure there are no restrictions on how you use your HELOC: Some lenders prohibit drawing funds for investments, real estate or otherwise.

• How does rental income affect an investment property HELOC?

  Rental income impacts a HELOC for an investment property in several ways. Lenders consider the cash flow from a property when evaluating your HELOC application. You’ll be asked to submit the real estate’s balance sheet and income tax statements. Lenders often like to see tenant rent or lease roll for the current and past two years also, along with proof of long-term tenancies. Their underwriters want to ensure that the property is profitable — or at least breaking even.

  On the plus side, any rental monies do accrue to your overall income, and how your overall debt-to-income ratio is calculated. This income also influences the perceived risk of default on the HELOC, which in turn influences whether you’ll get the money and on what terms.

Additional reporting by Mia Taylor