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Do you want to invest in property but don’t have the money to put it down? Maybe a home equity loan is a solution for you. Home equity loans are a great way to get started in property investing, as they offer a low-down payment option and flexible terms that make it easy to get started. Plus, you can use them to purchase any type of property, from a single-family home to an investment property.
So if you’re interested in investing in property, a home equity loan might be the perfect option for you. Before you decide to take out a home equity loan, be sure to talk to your lender about the terms and conditions of the loan. Also, make sure you are aware of all of your options – including refinancing or obtaining a second mortgage.
Using a Home Equity Loan to Invest in Real Estate
The interest rates for home equity loans are generally lower than those available on mortgages. Home equity loans also offer a higher level of flexibility in terms of the amount and timing of payments, as well as the type of loan product that you can get.
There are a number of important factors to consider when selecting a home equity loan to invest in real estate: your credit score, your financial situation, and the current state of the real estate market.
You must figure out if you can afford to save the full amount maturing on your home equity line and still have enough left over to purchase a property that is valuable and in need of work, or one which needs minor repairs for resale value. This generally means no less than 20% down before locking into an interest rate.
The main reasons why people take out this kind of loan are to renovate their current house. The major benefit of this loan type is that it allows you to make little or even no monthly payments while you get your home back on track; in many respects takes income out of savings to finance improvements needed for complete resale.
Another reason why US homeowners actually take out more home equity loans than their foreign counterparts might be because they are inexpensive, flexible (to a certain extent) at helping people finance the purchase of a property, and finally because they offer more choices in terms of funding types.
Unfortunately for pre-2007 modifications, it is extremely difficult to get back up to full rate via refinancing without losing major points on your FICO score. Unlike other methods that can go from 6.75% down to 3%, (or even 1%), this means you pay one interest rate for low rates during good times and very high rates if the housing market goes backward.
But despite this option, lenders still pretty much frown upon refinancing under these circumstances; especially as a follow-up to foreclosure proceedings (an idea that has disappeared from current policy wording).
But anytime anyone asks me whether they should refinance before their larger home equity loan matures, I generally advise that with such difficult parameters associated with getting anything where you want to finance at not bad rates, it is better to let the loan finish. At least you will avoid any prepayment penalties or monthly rate increases while your home recovers in value; which may take another two or even three years.
Given a moderate number of potential loan lengths available to choose from (30 – 40 transactions per year are typical), you really want this kind of lending when there is clarity as far as what each percentage amount would be at the time you wanted a refinance.
Refinancing is easiest when interest rates are lower; preferably at or below 8%. But as with all things home improvement, anticipation is important and it may be possible to find some of this money many years ahead if your needs have changed (i.e., the home value has risen and so does the amount needed).
Risks of Using a Home Equity Loan to Invest in Real Estate
There are a number of risks involved when using a home equity loan to invest in real estate, including owing more on your mortgage than the property is worth. Additionally, if the market does decline and you cannot sell the property for enough money to cover your outstanding debt and costs, you could end up losing both your investment and your home.
There are also potential tax consequences if you use a HELOC for investing in real estate. If you’re not self-employed or have other unusual circumstances, then most likely this type of loan will be classified as ordinary income rather than capital gains.
This means that it may subject you to higher taxes overall (including penalties) when sold or refinanced. With a HELOC loan, the lender cannot tell you how much interest or principal is due unless your balance goes over 20% of your home’s value.
Additionally, if you are in a high-interest rate area and decide to refinance your HELOC into a new loan with a lower interest rate, the mortgage company may require that you pay back any origination fees (paid by the lender) as well as any subsequent mortgage payments made on the lower interest rate loan.
It’s also very difficult to refinance an HELOC and consolidate debt into a new loan after it was originally used. Properly documenting all your expenses will make this easier, but if you don’t do the job right the first time then both APR on your existing loan and prepayment penalties are almost certain to increase in response.
As noted above many homeowners with small balances have significant equity simply from receiving mortgage interest payments each month as well as paying property taxes. In addition, even after making a down payment and/or securing other benefits like FHA financing or USDA qualified mortgages you are still likely to be able-bodied with only one estate at risk of accidental loss (the house itself) in the event your investments suffer significant losses.
For these reasons I’ve been more inclined lately to recommend that people who have enough equity free from non-mortgage debts stick to dedicated savings accounts all their own separate from their investment account.
This way they earn interest that is not subject to taxes, can be used for an additional down payment on their primary home purchase (assuming a lender hasn’t capped the amount of its general debt limit) and are also more likely to keep the funds liquid enough in case they need them.
If you make all your money work with investments directly tied up elsewhere even though it will cost lower yields because there’s no risk.