Can You Get a Home Equity Loan for an Investment Property?

How Do Home Equity Loans Work?

Before examining how home equity loans work on a second property, it's helpful to review how they work on principal residences.

A home equity loan is a secured loan that allows you to borrow against the equity you've built up in your home. Equity represents the amount of your home that you actually own; you can calculate it by subtracting your outstanding mortgage balance from your home's appraised value. Home equity loan funds are distributed in one lump-sum payment, which you repay at a fixed rate over your loan's term, which typically ranges from five to 30 years.

Home Equity Loan Requirements

Requirements for a home equity loan on your primary residence include:

• Sufficient home equity: Home equity lenders typically require you to have at least 15% to 20% equity in your home to qualify for a loan.
• Minimum credit score: You'll typically need a minimum credit score of 680, though some lenders look for higher scores.
• Low debt-to-income ratio (DTI): This ratio measures the percentage of your gross monthly income used to pay your monthly debt obligations. Many lenders set their DTI limit at 43%.
• Stable income and employment: Lenders will review your employment status and income to ensure your income is steady and strong enough to support a new loan payment. Be prepared to provide your W-2s and recent pay stubs as proof of income.
• A strong payment history on your existing mortgage: A long history of timely payments on loans and other forms of credit shows lenders you're a responsible borrower and likely to make good on a new home equity loan.

Home equity loans help homeowners cash out equity at lower interest rates than other forms of credit, which they can use to renovate their homes or make major repairs. These benefits also extend to second homes, where you can obtain a home equity loan for home improvements, repairs or other purposes.

Home Equity Loan vs. HELOC

You can tap into the equity in your investment property using a home equity loan or a home equity line of credit (HELOC). These options are structured differently, however, so you'll want to review their features to see which one, if either, is a good fit.

If you need money upfront for a major renovation or to purchase another property, a home equity loan's fixed rate and predictable payments can make it easier to manage your budget. On the other hand, if you're a rental property owner or a real estate investor who wants ongoing access to funds for repairs or new opportunities, a HELOC's flexible credit line may be a better fit. Explore the pros and cons of home equity loans and HELOCs to help you decide if either of these options works for you.

How to Get a Home Equity Loan for an Investment Property

While home equity loans on investment properties aren't as widely available as traditional ones for borrowers using their primary residence, they're still possible to obtain. Fortunately, the process is relatively simple, and you can help to ensure it goes smoothly if you understand what lenders are looking for going in.

Follow these steps to get a home equity loan on an investment property.

1. Check Your Qualifications

Before applying, you should have a solid idea of whether you're qualified for a home equity loan. The requirements for investment properties tend to be stricter than for loans on primary residences, so it's important to understand what lenders expect before you apply.

• Higher credit scores: Lenders may require a 680 credit score for a traditional home equity loan, though some work with lower credit borrowers with scores as low as 620. However, you'll likely need a score of at least 720 to qualify for a home equity loan on an investment property.
• Lower loan-to-value (LTV) ratio requirements: Loan-to-value ratio is the percentage of your property's value you can borrow. You may need a lower LTV—typically around 70% to 80%—for a home equity loan on a rental or investment property. By contrast, when borrowing against your primary residence, your lender may allow an LTV as high as 85% or even 90%. This means you can borrow less relative to your property's value on a second property compared to a primary residence.
• Varying DTI requirements: Lenders often look for DTI ratios similar to those required for primary residences, typically below 43%. But, some may be more—or less—cautious depending on their perceived risk of the investment property, with DTI caps ranging from 43% or lower to 50%.

2. Calculate How Much You Can Borrow

While you're at it, you should run the numbers to get a general idea of how much you may qualify to borrow and make sure it's enough to meet your goals. Your borrowing limit depends on the amount of equity you have and the lender's guidelines.

Lenders will look at your finances to determine your loan-to-value ratio. As noted above, your lender may require a lower LTV than if you were borrowing against your primary residence. This means you can borrow less relative to your property's value on a second property compared to a primary home.

3. Shop Multiple Lenders

If you determine you're a good candidate for a home equity loan, the next step is to get quotes from multiple lenders, including traditional banks, credit unions, online lenders and mortgage companies. Prequalifying with lenders can help you discover what amounts and rates you may qualify for without impacting your credit, and doing so makes it easier to compare offers.

As you shop lenders, you may find higher interest rates for home equity loans on an investment property, as lenders often view them as riskier than primary residences. They may believe that if you run into financial difficulties, you're more likely to walk away from the investment property than the one you live in. To compensate for this elevated risk, lenders typically charge higher interest rates. Similarly, repayment terms for rental or investment properties are often shorter—such as 10 to 15 years—compared to terms of up to 30 years available for primary residence loans.

4. Apply for a Home Equity Loan

Once you've identified the best home equity loan for your situation, it's time to submit your application. Your lender will ask for documents that support the information you include on your application, and you'll want to submit them promptly to keep the process moving along.

Be prepared to submit some personal information including a government-issued ID, your address, date of birth and Social Security number. You'll also need to verify your income with recent pay stubs and W-2s. Your lender should also ask for your bank statements and tax returns to assess your financial stability and ability to repay the loan.

5. Close on the Loan

Once approved, you'll close on your home equity loan by reviewing the documents and making sure the contract matches what you've agreed to. After signing, you'll receive a lump-sum payment, which you'll repay through monthly installments at a fixed interest rate.

Tip: Be aware there is no right of rescission for loans on investment properties. For certain loans secured by your primary residence, this three-day cooling-off period allows you to cancel the loan without penalty if you change your mind. You won't have that luxury with a home equity loan on an investment property.

Alternatives to a Home Equity Loan

Home equity loans aren't for everyone. If you'd rather explore other options, consider these alternatives:

HELOC

Similar to a credit card, a home equity line of credit is a revolving credit line you can use as needed to make major repairs and home improvements to your investment property. You'll make interest-only payments at a variable rate during the HELOC's initial draw period, which is typically the first 10 years. You'll then enter the repayment period and make principal and interest payments for the remainder of the term, usually 20 years.

Having the ability to withdraw money as needed up to your credit limit is especially useful for projects you are completing in stages or when you have unexpected expenses like a contractor going over budget.

Cash-Out Refinance

With a cash-out refinance, you'll pay off your primary mortgage with a new, larger loan and receive the difference as cash. The amount you may qualify for will depend on how much available equity you have in your property. You can use the money for just about any reason, like making improvements to your property, putting money down on another property or funding major repairs or upgrades.

Bridge Loan

A bridge loan is specifically designed to help homeowners and investors buy a new home while they're selling their current one. This short-term loan option may benefit you if you're just looking for cash for a rental or investment property and the funds on the home you're selling won't be available to use as a down payment on the new one. Before taking out a bridge loan, you should have a plan for repaying it because its repayment term is typically just six to 12 months. It's common to use the money from your home sale once it closes to pay off the bridge loan.

Strengthen Your Credit to Improve Your Approval Odds

A home equity loan can give you cash for a down payment on another property or to fund renovations that improve your investment home's value. It's a practical way to access equity without needing to sell the property.

If you decide to move forward with a home equity loan, remember that having good credit could improve your likelihood of approval and securing a favorable interest rate. You can check your credit report and FICO^® Score^☉ for free with Experian to see where your credit stands. Take steps to resolve any issues you find on your report and strengthen your credit before applying.