Can you take out a mortgage on a rental property?

If you own more than one propertycan you borrow against all the equity you have built up to finance a significant expense.

When you withdraw one housing loan and using your home as collateral, however, it is important to be aware of the advantages and disadvantages. For a home loan, an investment property and a rental property are treated in the same way; you can borrow against equity in both.

Here’s what you should know about borrowing against your equity in a rental property (or other non-primary residence) and why other types of financing may be a safer bet.

What is home equity?

Your equity is the difference between what you owe on your mortgage and the current value of your home. You build equity in your home by consistently making mortgage payments over the years. Most lenders expect you to have at least 15% to 20% equity in order to approve you to borrow money against your primary residence. When it comes to a rental property, lenders usually require higher levels of equity for approval because it is a riskier loan for them.

Risks of using home equity to finance a second property

Using a home equity loan or HELOC to borrow against an investment property is a risky move. That means you’ll be on the hook for three mortgage payments a month, which is a big financial commitment even if you can comfortably afford the payments.

The use of mortgages and mortgages, or HELOCs, hit record highs during the pandemic thanks to rising home values ​​and low interest rates that made borrowing money cheap. But like the Federal Reserve increased prices until 2022, it has become dramatically more expensive to borrow against a home, regardless of whether it is a primary home or not.

“Home equity rates are the highest they’ve been in 15 years, and it’s going to cost you even more on anything other than a primary residence,” said Greg McBride, financial analyst for CNET’s sister site Bankrate. “People often look at home equity as bargains. But it’s no longer a cheap source to borrow with the way interest rates have gone up this year.”

What is a home loan?

A housing loan allows you to borrow money against your existing capital and gives you a lump sum of cash at a fixed interest rate and a fixed repayment schedule. Your monthly payments will always be consistent and your interest rate will never change.

What is a HELOC?

A HELOC is a revolving line of credit that works more like a credit card. You don’t get your money all at once and instead you can make as many withdrawals as you need over a longer period of time. HELOCs have variable interest rates, so your monthly payments will fluctuate, compared to home loan payments that stay consistent.

What is a rental property?

A rental property is any property you buy with the intention of generating income by renting it out to tenants. Any rental property you use to make money can also be called investment property.

How to Get a Home Equity Loan or HELOC on a Rental Property

As with any loan or mortgage, you want to have all your financial ducks in a row before you apply. Although home appraisals can now be done virtually, it is likely that your lender will require one or two in-person appraisals to confirm your home’s value.

Calculate your loan-to-value ratio

Calculate your loan-to-value, or LTV, ratio, which is simply the current appraised value of your home divided by the remaining balance. Most lenders prefer an LTV of 85% or less for primary residences, but will likely require an even lower LTV for an investment property.

Review your credit history

In addition to your available capital, lenders generally require a credit score of 700 or higher to make this type of loan. The higher your score, the better rates and terms lenders will offer you. Before applying, review your credit report for accuracy. For a primary residence, lenders typically want you to have a debt-to-income, or DTI, ratio between 36% and 43%. For a rental property, the threshold may be lower.

Gather your financial papers

You must demonstrate that you can repay your loan over time by providing proof of income and employment with tax returns, pay stubs and W-2s. You will also need to show current mortgage statements for the homes you already own to show that you have made payments on time. For a rental property, you will need to show proof of renters insurance and will likely also need to provide copies of your tenants to show that the home is occupied and generating income.

Compare lenders

Not all lenders offer home equity loans or HELOCs for investment properties because they tend to be riskier. The more lenders you interview, the better your chances of finding the most favorable rates and terms. Some lenders may offer lower interest rates that seem cheaper, but include higher fees that can take away any savings. Make sure you understand the total cost, including any additional lender and third-party fees.

Alternative to a home loan or HELOC when financing a rental property

There are other types of financing that do not require you to take out a second mortgage on your apartment building. And with current interest rates, you may not save as much with a home equity loan or HELOC compared to another type of loan.

“There are a lot of home share rates that have reached double digits and they’re still going up because The Fed is still raising interest rates“, McBride says. “You’re not going to make a bargain by leveraging equity in a rental property or an investment property.”

Personal loan: A personal loan is an unsecured loan so it will have a higher interest rate and lower credit limit than a home loan, but it will not require you to put up your rent as collateral. The average personal loan interest rate is several percentage points higher than a HELOC, according to Bankrate.

Refinancing of withdrawals: A payout refi replaces your current mortgage with a new mortgage that has more favorable interest rates and terms. The equity you borrow is added back to the balance of your new mortgage and you pay it off during your loan term. But with interest rates near two-decade highs, this option probably won’t make sense for most homeowners who have already locked in a lower rate.

Credit card: A credit card is also unsecured debt that will have a higher interest rate than a home loan, but you won’t be at risk of foreclosure and you can also take advantage of credit card rewards programs.

The point

You can take out a home loan on a rental property, but doing so means you have to make three mortgage payments each month. When you borrow against your equity, you use the property as collateral to secure the loan, so if you default for any reason, your lender can repossess the house. With interest rates continuing to rise and home equity prices at a 15-year high, borrowing against an investment property is not worth the risk of foreclosure if you have access to other types of financing.

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