Investing in real estate is one way to build generational wealth for the future while bringing in passive income for today. Yet if you’re looking to build up your investments through a rental or investment property, you’ll need to come up with a good chunk of capital to get started.
Just like buying a primary home, financing an investment property through a mortgage comes with a down payment and closing costs. And you may need to borrow money if you don’t have much savings.
For homeowners looking to leap into real estate investing, you might be able to tap into your home equity to finance your purchase. Home equity rates are at two-year lows, and strong growth in home values has resulted in more than $200,000 in tappable equity per homeowner, according to the ICE Mortgage Monitor.
Getting into the real estate investment game comes with risk, however. Here’s what to know before using your home’s equity for buying an investment or rental property.
Should you use your home equity to invest in real estate?
While you can use a home equity loan to buy a rental or investment property, that doesn’t mean you should. Borrowing from your home equity is risky, especially if you don’t know if an investment is a sure thing.
Among the two most popular ways to tap into your home’s equity are home equity loans and HELOCs — short for home equity lines of credit. Both types of loans are ways to borrow from the money you’ve already paid into your home, based on your home’s appraised value. Many folks use home equity loans and HELOCs for home-related projects, like repairs, improvements or renovations that can increase your property’s value. They’re also used for high-interest debt consolidation, to pay for education costs or to cover medical bills or other unexpected costs.
But there are no restrictions as to how you can use the money you borrow with a home equity loan. As long as you have the equity, income and credit history needed for approval, you can use your funds to invest in real estate or buy a rental property.
Keep in mind that taking out a home equity loan is like a second mortgage. If you don’t repay what you borrow, you risk losing your home to foreclosure.
💡How to calculate your home equity
Every mortgage payment gets you one step closer to owning your home outright. The part that the bank owns is what you pay in your mortgage every month. Home equity is how much of your home you own compared to what you owe — or what’s left — on your mortgage.
You can calculate your home equity by taking your home’s current value and subtracting what you owe on your mortgage. The final number is your home equity.
[home’s value] ➖ [mortgage balance] 🟰 [home equity]
Dig deeper: How to build equity in your home more quickly (and why it matters)
Risks to using home equity to invest in a rental property
Using a home equity loan can unlock access to the cash you’ve already paid into your home. These lending products tend to have more favorable loan terms compared to unsecured personal loans, like lower interest rates and longer repayment periods.
But because home equity loans and HELOCs use your property as collateral to secure the loan, they also come with a huge risk: Missing or falling behind on your loan’s payments could result in you losing your home to foreclosure.
Another big risk comes down to the unpredictability of the real estate market. While median home prices have increased nearly 70% over the past five years, according to the Case-Shiller National Home Price Index, it’s not easy to predict what will happen with your home’s value or the potential return. If it were to decrease significantly or depreciate, you could end up owing more on your loan than your primary residence is worth — a financial situation referred to as being “underwater” on your loan. If this were to happen, you could end up needing to sell your home to pay back your home equity loan on time, however unlikely it might sound.
Risks of investing in real estate
Real estate leads as the best long-term investment, according to most Americans in a recent Gallup poll, with 36% of those surveyed choosing real estate over stocks, mutual funds, gold and other options. But real estate investing has its risks as well.
While the market is red hot right now, it’s important to remember that the market won’t always go up or stay up. The market crash of 2007–2008 and protracted Great Recession that followed was difficult for homeowners and investors alike, resulting in some 3.8 million foreclosures between 2007 and 2010 estimated by the Fed.
Deciding which properties to invest in takes research. You’ll want to understand the general demand, market value, vacancy rates and estimated taxes of the areas you’re interested in, not to mention the available homes or buildings themselves. And you’ll need to factor in long-term maintenance, such as necessary repairs as the structure ages and time to manage future tenants, if you plan to rent it out for passive income.
Other long-term maintenance includes staying up to date on local laws and ordinances related to zoning, compliance and other laws as a homeowner or property owner. You’ll have to pay attention to permits, laws that could get passed, tax rates and more.
Unless the new property can at least pay for itself, you run the risk of losing two properties if your investment doesn’t pan out. The debt and uncertainty might be too much for some folks investing in real estate without careful consideration, a strong budget, high risk tolerance and a stomach for unreliability.
Dig deeper: Top 7 common home equity myths — debunked
Benefits of using home equity to invest in a rental property
If you’re comfortable with the risks associated with real estate, using your home equity could be a way to invest in a new property or rental income over other types of financing.
You can get quick access to cash
A home equity loan gets you quick access to the cash you’ve already paid into your home. You won’t need to take out a new mortgage on the property — which could come with a lengthy application, approval and closing process.
Your interest rate could be lower
A home equity loan is a secured loan that uses your home as collateral. Secured loans typically offer lower interest rates than unsecured loans, like personal loans. The less interest you owe on a loan, the lower your monthly payment — or the more money you can put toward your loan’s principal to pay down what you borrow faster.
You can increase your down payment
Because home equity loans pay out what you borrow in one lump sum, it could mean that you have more money up front to increase your down payment on an investment property. Generally, the higher your down payment, the lower your monthly payment. And if you can put down at least 20% of your property’s purchase as cash, you won’t be responsible for private mortgage insurance — or PMI — which can save you up to $70 a month for every $100,000 borrowed, according to Freddie Mac.
Investment properties tend to have stricter financing requirements. Using your loan proceeds to increase your down payment or the cash you have on hand could make it easier to afford the investment property in the long run.
Dig deeper: 4 ways to tap into your home’s equity
Loan options for using your home equity to buy an investment property
There are a few ways to borrow from your home equity. How you borrow from your home equity could determine how you receive, repay and spend that money on an investment or rental property.
Home equity loan
A home equity loan is the most popular way to use your home’s value to invest in real estate. This type of loan provides the amount you borrow up front in one lump sum. You then make monthly payments until your loan is paid back in full. Home equity loans usually come with fixed interest rates and terms upward of 30 years, much like a traditional mortgage.
A home equity loan is best if you know how much you need to borrow and prefer to keep the same monthly payment for the life of your loan.
Home equity line of credit (HELOC)
A HELOC is a revolving line of credit, similar to the way a credit card works. You’ll take money out as needed during what’s called the draw period, which usually lasts about 10 years. After the draw period comes your repayment period, which can last about 15 to 20 years. Your payments are amortized to make sure you can pay off what you’ve borrowed plus interest on time.
Unlike a fixed-rate home equity loan, HELOCs come with variable interest rates. Depending on your lender, you may be able to make interest-only payments during the draw period, though you can often pay toward your principal too.
A HELOC might be a good idea if you haven’t determined exactly how much you need to borrow and want to borrow from your line of credit as needed — say, to pay for repairs or maintenance on your investment property.
Cash-out refinance
With a cash-out refinance, you’re replacing your primary mortgage with a new home loan whose amount is more than you owe. You can then use your new loan to pay off the remaining balance of your old mortgage, “cashing out” the remainder of what’s left.
Whereas traditional refinancing replaces one mortgage for another with more favorable repayment terms for the borrower — like lower monthly payments, a lower loan interest rate or both — a cash-out refinance creates a larger mortgage payment. It might be worth it if you can afford the new payment on your current home while using the cash to buy an investment property.
Dig deeper: When should you refinance your mortgage? 4 times it’s worth it
How to get a home equity loan for an investment property
If you’re ready to get a home equity loan to buy an investment property, confirm you can meet minimum requirements and ready your documentation for providing to your lender.
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Check your credit score. Credit requirements tend to be stricter for investment properties compared to primary homes. The exact credit score you need varies by lender, but the higher your credit score, the more likely you are to qualify for the full loan amount you want to borrow.
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Gather personal and financial documents. Get your tax returns, bank statements, government-issued IDs and other documents ready for your application. Your lender may ask for pay stubs, benefits statements, W2s and other financial statements for income verification and to prove you’re responsible enough to repay what you borrow.
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Make sure you have enough equity. Lenders have restrictions on how much you can borrow. Your combined loan-to-value ratio (LTV) — your primary home and your home equity loan — can’t be more than 80% of your home’s value, although the LVT varies based on the lender you go with. You should have at least 20% equity in your home before you take out a loan or line of credit.
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Get preapproved. Like a traditional mortgage, preapproval for a home equity loan lets you know how much you might actually qualify for. Scoring models allow at least a 14-day window in which you can shop for rates from different banks, credit unions and other lenders and have it count as a single query on your credit, while FICO specifically allows for up to 45 days.
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Compare and apply. Compare lenders to see which offers the best rates, fewest fees, longest repayment terms and fastest approval. Lenders that offer home equity loans often have different eligibility requirements, so see which ones you’re eligible for before completing an application.
When completing an application, your lender will let you know if you need to send along any extra documents or paperwork. Underwriting could take a few weeks or up to a month before your application is approved.
Do I need an appraisal for a home equity loan?
While many home equity loans require an appraisal to determine your home’s current value, if you have excellent credit, you might be able to find a lender that offers no-appraisal home equity loans. These loans use digital tools and hybrid models that assess your home’s features and recently sold homes in your neighborhood, among other factors, to determine your home’s value. Start with specialty digital lenders like Figure or LoanDepot. And learn more about how they work and what to expect in our guide to no-appraisal home loans.
Dig deeper: Fact vs. fiction: Top 8 common home equity myths — debunked
Alternatives for financing an investment property
While using your home equity is one way to buy an investment property, you have other ways to fund your real estate ventures, including conventional loans and all-cash purchases.
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Conventional bank loan. Many mortgage lenders offer conventional loans for second homes, vacation properties and investments. Criteria to qualify may be more strict than for a primary property but can vary widely by lender, area and property use. Digital lenders like Rocket Mortgage and SoFi streamline the application and underwriting process online with secure scanning and uploading of your documentation, while lending marketplaces like Quicken Loans can match you to multiple quotes with one query.
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Peer-to-peer (P2P) loan. There are a few peer-to-peer lending platforms that match up investors with borrowers to help them finance real estate purchases, including PeerStreet and Fundrise. However, you might pay higher fees and interest rates than on other loan options for the convenience.
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Personal loan. Most personal loans are unsecured, meaning you won’t lose your home if you fall behind on payments. But they tend to come with higher interest rates and shorter repayment terms than home equity lending options. You may not be able to borrow the entire amount you need to fund your investment with a personal loan, compared to a home equity loan or traditional mortgage.
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Cash. Using your savings is among the easiest ways to avoid borrowing. It’s likely to take longer to achieve your financial goal, depending on the area you’re interested in investing in, but it means you won’t need to pay interest, take out loans — or give up your home if you find yourself underwater. Start with our editor’s picks for the best high-yield savings accounts on the market today.
Dig deeper: Personal loan vs. home equity loan: Which is the best fit for your financing?
FAQs: Home equity loans, HELOCs and your finances
Still have questions about whether it makes sense to tap into your home’s value? Learn more about home equity, taxation and your finances. And read our growing library around home loans and mortgages.
Can I borrow 100% of my home’s equity with a home loan or HELOC?
No, this is a common misconception about home loans. Very few lenders will finance a loan for 100% of your home equity. Most legitimate lenders allow you to access up to 80% or 85% of your home’s equity, depending on your credit score and the lender. We debunk similar misconceptions for this type of borrowing in our guide to the top common home equity myths.
Is the interest I pay on a home equity loan tax-deductible?
It depends on how you use the loan. The IRS advises that interest payments on home equity loans and HELOCs are deductible “only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan your home and if the loan meets other tax regulations.” Speak to a tax advisor or find a trusted financial advisor to learn how to document your expenses and stay within the law when filing your taxes.
Can I use my home equity to pay off credit card debt?
Yes. Typical interest rates on home equity loans are lower than those of the average credit card and personal loan, and tapping your home’s value to pay off high-interest debt could significantly lower the interest amount you’ll pay on these separate debts. But there’s a lot at stake if you aren’t able to repay your home equity loan on time, including the potential loss of your home to foreclosure. Make sure any new loan you take on offers enough wiggle room in your budget for emergencies and unexpected expenses.
What’s the best way to quickly build equity in my home?
For new homeowners, making the biggest down payment you can comfortably afford is among the best ways to build instant equity in your home — depending on the amount, it might also reduce your interest rate and keep you from having to pay PMI. Other steps for existing homeowners include making biweekly payments and putting extra money toward your principal, when you can. Learn more in our guide to our top five ways to more quickly build home equity
What counts as retirement income when buying a new property?
When you’re retired, lenders will want you to prove there’s enough money in your retirement accounts to help cover loan payments through the end of the term. The good news is that your retirement income might actually count for more than you think. That’s because mortgage lenders typically “gross up” certain types of nontaxable income when calculating your DTI — by as much as 25%, depending on the type of mortgage you get. This includes Social Security, nontaxable retirement income, military allowances and more. Learn more in our guide to buying a home in retirement.
What are the monthly payments on a $400,000 home?
Your monthly payment is influenced by more than just rates, but on a traditional 30-year fixed-rate mortgage, you can expect to pay from about $2,400 a month at 6% interest to about $3,000 a month at 8% interest. Your mortgage loan term, repayment frequency, insurance costs, property taxes and potential private mortgage insurance (PMI) all affect how much you’ll pay each month, as well as the total interest you’ll pay over the life of the loan. Learn more about what you might pay and how to afford a mortgage in our guide to buying a $400,000 property.
How much does a 1% drop in rates really matter?
It depends on the loan, but a single percentage point can add up to substantial savings over the life of a large loan like a mortgage. For the average borrower, a rate reduction of just 1% could mean a six-figure reduction in the interest you pay over the life of the loan. It also increases your chance of approval, because lower rates typically mean lower monthly payments, which tell lenders you’re at less risk of defaulting on the loan. Learn more about how much a 1% rate change can affect your purchasing power in our guide to decreasing mortgage rates.
Editorial disclaimer: Information on this page is for educational purposes and not investment advice or a recommendation to buy any specific asset or adopt any particular investment strategy. Independently research products and strategies before making any investment decision.
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About the writer
Dori Zinn is a personal finance journalist with more than a decade of experience covering credit, debt, investing, real estate, student loans, college affordability and personal loans. Her work has been featured in the New York Times, the Wall Street Journal, Yahoo, Forbes and CBS News, among other top publications. She loves helping people learn about money.
Article edited by Kelly Suzan Waggoner
