How to Use a Home Equity Loan for an Investment Property

The purchase of a home is a huge investment and this especially true if you’re able to leverage it the right way. The further you are in paying off your mortgage, the more value your home has and it can be used to build your wealth. Home equity has to do with how much of your home you own. It’s about how much you’ve paid into it. You can get a home equity loan against the equity you’ve built by paying off your mortgage, using your property as collateral that you can build from.

There are varying reasons that a homeowner will choose to take out a home equity loan. It may be to purchase another property or it could be used for improvements. Another loan type is a HELOC, which is a line of credit secured by your home. You can withdraw funds whenever you need them so it offers a bit more freedom than a home. We’ll give you more insight on how to use your home equity loan to buy an investment property.

Quick Links

1. What is a Home Equity Loan?
2. Who Should Get a Home Equity Loan?
3. Types of Home Equity Loans
4. Who Offers Home Equity Loans?
5. Things to Watch Out For with a Home Equity Loan
6. Benefits of a Home Equity Loan
7. Frequently Asked Questions About Home Equity Loans

What is a Home Equity Loan?

To keep it simple, a home equity loan is approved by a financial institution and secured by the property you currently own. The more you’ve paid your mortgage down, the more equity you have. This equity can be used to take out a loan.

To further break it down, if you have a home with a worth of $500,000 and you’ve paid $200,000, you’ll have $200,000 in equity. You can then have a lender bring the loan-to-value to 80%, giving you a loan of $100,000.

Who Should Get a Home Equity Loan?

As a homeowner, if you’re looking to invest in a second home or make some home improvements to add more value to your property, a home equity loan is for you. It’s important that you have consistent incoming money coming in as well.
There are some factors that you should consider such as:

• The current value of your property.
• How much of the mortgage has been paid.
• The balance of the mortgages that are secured by your home already.

These factors are important because you don’t want to have more debt than you can handle. If you are certain you can pay back the additional funds that may apply, a home equity loan could be right for you.

Types of Home Equity Loans

There are a few different kinds of equity loans that are available to you. You can get them through your bank, lending, or financial institution. The type of loans available when it comes using your home as collateral include:

Fixed-Term Equity Loan

This loan will give you a lump sum with payments that are amortized over a certain amount of time.

Home Equity Line of Credit (HELOC)

This type of loan acts in the same way a credit card does. You can withdraw whatever amount you want within the limits of what you’ve borrowed. There is a validity period with it. HELOC gives you a bit more freedom to use the money as you like.

Home equity loans and HELOCs are both secured by your home. You can take out an equity loan or line of credit through leveraging your property. As you’re using your home for collateral with either of these loan types, you get much better interest rates than with credit cards and personal loans.

While a home equity loan comes with fixed payments and interest rates, HELOCs are considered revolving credit lines. The interest rates are variable so the minimum payment amounts may change. Draw periods of HELOCs let you take funds out from your line of credit as long as you continue to make interest payments.

Do be aware that it’s not always easy to get home equity loans in some cases. An investor is considered more of a risk as they are more likely to default on their investment property as opposed to doing so with their primary residence. Banks and other financial institutions may not give these loans out easily.

If you have large outstanding debts, you may also find it challenging to qualify for any type of home equity loans. If you have a current mortgage, a car loan, and credit card debit, borrowers may refer you to an alternative lender.

Lenders will use criteria to make a decision on lending you the money. This can include the available cash in hand you have as well as your credit score and debt-to-income ratio. If your debit-to income ratio is high, traditional banks may not loan you the money despite the equity you already have.

Who Offers Home Equity Loans?

Banks and other traditional financial institutions offer home equity loans. However, it’s not always easy to get these types of loans through traditional means. They may refer you to alternative lenders if they’re not able to offer you a loan.

These lenders include trust companies or private mortgage lenders. There are some benefits to these more flexible mortgage lenders. They will often offer you a locked in rate with lower interest. Often, they’ll offer you funds more quickly than you’d get them at a bank.

Alternative lenders will base how they lend on the value of your home and any of your outstanding loans. These lenders make it more possible to more types of homeowners looking to get an equity loan.

Things to Watch Out For with a Home Equity Loan

Home equity lines of credit (HELOC) can be worthwhile as it allows you to improve the value of your home. However, it’s important to use the funds that are affordable with the income you have currently. If you spend more than what you have, it becomes bad debt.

You’re putting your primary residence at risk by using a home equity loan to purchase a new property if you can’t handle. You’re also going to have to juggle multiple loan payments. If you have a mortgage on your primary residence and second along with a home equity loan, that’s three payments you need to make monthly.

You may likely pay higher interest rates than on a mortgage as home equity products generally have a higher interest rate compared to mortgages. You’re going to have to pay for closing costs when you use equity to buy another property. These can range from 2% to 5% of the loan amount.

With an equity loan of any type, you won’t be able to take another loan out for emergencies. If you put the lump sum of an equity loan into purchasing another property, you’re somewhat tied up financially for awhile.

Benefits of a Home Equity Loan

Taking out a home equity loan, using your home as collateral does come with some benefits. They are as follows:

• Costs less
  • The interest rates are lower than what you would get with unsecured loans and credit cards.

• Increases credit
  • You can improve your credit score and history once you have the loan and have started to pay off the principal.

• Making good use of assets
  • A home equity loans lets you utilize a part of your net worth. This isn’t always easy to do. If the value of your property grows since you purchased it, you have a good principal amount you can leverage while using a home equity loan.

• Aligns with financial goals
  • You can take out a home equity loan and keep savings intact. Financing doesn’t take away from your long-term saving goals and development of wealth.

Frequently Asked Questions About Home Equity Loans

How soon can I get approved for a home equity loan?

Getting a home equity home approval can take between a week to a few months depending on the circumstances. Alternative lenders will often be the quickest even when it comes to lump sums.

What are normal terms for a home equity loan?

A home equity loan terms can range from 5 to 30 years. The HELOCs will often have a withdrawal time limit of 10 years with up to 20 years to repay. A cash-out refinance term can be good for as much as 30 years.

What credit score would I need to qualify for a home equity loan?

To get a home equity loan from the bank, you’ll likely need to have a 660 to 680 credit score. You can still qualify with some lenders if you have a 620 but these loans may come with higher interest payments.

Will there be closing cost involved?

When you’re borrowing against equity in your home, you may also have to pay for closing costs. These costs can range from 2%-5% on the total amount of the loan. Fees will be different depending on your lender. Do be sure to compare the closing costs as this can save you quite a lot of money.

Will I need to have an appraisal done to get a home equity loan?

Yes, there will need to be an appraisal on your home so they can figure out the worth of your property. This allows the lender to give you a loan that doesn’t put them at risk. It helps to protect the loan from defaulting. A lender needs to know that you can make your monthly payments on a long-term basis. An accurate appraisal protects you and the lender.