Americans are sitting on more than $34 trillion worth of home equity.[1] If you’ve built up equity in your home, you may be wondering whether it can help you achieve your financial goals sooner. Specifically, can you use a home equity line of credit (HELOC) to fund an investment property and start generating new income?
The big advantage of doing so is that instead of spending years trying to save up for the down payment on an investment property, your home equity can provide a convenient short cut. That way you can start earning rental income sooner.
But the downsides are real. If your investment fails to deliver the cash flow you’re hoping for, you risk not only losing your investment property, but your primary residency as well.
In this article we’ll help you understand how using a HELOC for an investment property works, what the benefits and drawbacks are, and how to figure out if this path makes sense for your situation.
How using a HELOC for an investment property works
A HELOC is a revolving line of credit (similar to a credit card), but one that is secured by the equity in your home. You typically have a draw period of around 10 years during which you can withdraw, repay, and withdraw again from your HELOC as needed, paying only interest on the withdrawn amounts. Once the draw period ends, you begin repayment of the principal, which often lasts for 10–20 years.
Using a HELOC to buy an investment property is usually done by putting the withdrawn HELOC amount toward your down payment. Lenders usually require 20–25% down on investment property mortgages, making the down payment one of the biggest hurdles for property investors to overcome, something a HELOC can help with. Once the property is secured, many investors will then refinance to a fixed-rate loan — transferring the HELOC balance to the long-term mortgage and using the rental income to make the monthly payment.
However, you aren’t limited in what you use your HELOC for. It can also be applied to renovations, which may help bring in more rental income to pay down your mortgage.
Why a HELOC can be a great tool for buying an investment property
Unlike a home equity loan, which provides credit on a lump-sum basis, with a HELOC you only pay interest on what you withdraw, not the full credit amount. As a result, your monthly payment amounts can be kept low while you get your investment property ready. Plus, because your HELOC is backed by your home’s equity, you can access better rates than you’d be able to with unsecured credit.
“The cost of money on a hard money loan is much higher than that of a HELOC," says Daniel Cabrera, owner of Sell My House Fast SA TX. "Therefore, if I can utilize my HELOC in funding my capital stack on my deals, I will be able to save on costs. A HELOC is also revolving — if I pay off my HELOC on my flipped house, that money is immediately available for my next deal.”
A HELOC also gives you more flexibility than a lump-sum loan, says Chris Kuclo, Head of Agent Relations at Best Interest Financial. “A HELOC beats a home equity loan when you're still shopping and don't know the exact down payment amount yet — the flexibility to draw exactly what you need, when you need it, is genuinely valuable when the deal isn't locked, and you're only paying interest on what you actually use rather than carrying a full fixed loan from day one.”
That said, a HELOC should be treated as a short-term bridge rather than a long-term solution. Many savvy investors treat a HELOC as a way to get a down payment secured with the plan to eventually refinance into a fixed-rate loan once the investment is secured. Because HELOCs typically come with variable rates, they expose investors to far too much rate exposure if held long-term.
Risks of using your home equity to fund an investment
Using a HELOC to fund an investment comes with risks. While some risks, like using your home as collateral, may be obvious, others often get overlooked.
Your home is the collateral
Using your primary residence as collateral for an investment is always risky. If your investment underperforms due to extended vacancy, high repair costs, or a change in market conditions, you’re still obligated to make payments on your HELOC. Missing payments risks your home being repossessed.
You're carrying two properties simultaneously
You’ll need to be able to manage the monthly obligations on two properties, including interest, investment mortgage, taxes, insurance, maintenance, and a vacancy reserve. You’ll also need to ensure you have cash flow to account for at least a month or two of vacancy.
“As far as rentals are concerned, the deal must cash flow positively after paying the mortgage and the remaining HELOC balance," says Cabrera. "If appreciation is the sole means of making the deal work, then the risk of the HELOC is unnecessary.”
Variable rate uncertainty
HELOCs typically come with variable interest rates that are tied to the Prime Rate. Given that the Prime Rate has swung from as low as 3.5% to as high as 8.5% in the past five years, there’s significant risk of rate exposure.[2] You’ll need to model what your HELOC payments and cash flow will look like if interest rates climb another percentage point.
“You need enough room in the deal to account for the interest paid on the HELOC as part of the carrying costs and still make the deal profitable," notes Cabrera. "If the HELOC interest is going to eat so far into the deal that the deal is only going to work if everything goes perfectly, then the deal is not worth the risk.”
Eroding equity on your primary asset
Home equity gives you a financial cushion that a HELOC ends up eroding. By tying up your equity in your HELOC, you’ll have less to spare if you need to access credit for other purposes.
Plus, if home values go down while you still have an outstanding HELOC balance, you could find yourself lacking the equity needed to cover the balance plus your other obligations. This is especially true if you end up needing to sell or refinance while home values are low.
Qualifying for a HELOC to buy an investment property
It’s easy to overlook the fact that when using a HELOC to buy an investment property, you actually have to qualify for two loans: the HELOC itself and the investment property mortgage. Not only does each product have its own underwriting standards, but they interact with each other in a way that makes qualifying more complex.
Qualifying for the HELOC
Fortunately, standard HELOC requirements apply when using your primary residence as collateral. You’ll typically need a credit score of 680 or higher (although 640-660 is possible), a combined loan-to-value (CLTV) of 80–85% or below, a debt-to-income (DTI) ratio that can absorb the new payments, sufficient cash reserves, and an appraisal.
However, if you use another investment property as collateral for a HELOC, the requirements will be much higher. Investment-backed HELOC guidelines demand stronger credit scores, more equity, and larger reserves.
“Most lenders want to see you retain at least 25–30% equity after the line is factored in, compared to the 15–20% cushion typically required on a primary residence," says Kuclo. "Credit score minimums jump meaningfully too; where a primary HELOC might approve at 640–660, most lenders want 700 as a floor on an investment property, and you're not seeing the best pricing until you're at 740 or above. DTI requirements tighten to roughly 40–43% versus the 43–45% ceiling common on primary products, and cash reserve requirements are notably more aggressive.”
| Primary Residence HELOC | Investment Property HELOC | |
|---|---|---|
| Credit score | 640+ (ideally 680+) | 700+ (ideally 740+) |
| Max CLTV | 80–85% | 70–75% |
| DTI limit | 43–45% | 40–43% |
| Cash reserves | 2–3 months | 6–12 months |
| Appraisal | Sometimes required | Always required |
Qualifying for the investment property mortgage
The real complexity happens when applying for an investment property mortgage. There are two issues that you’ll need to be aware of early on: down payment sourcing and DTI stacking.
Down payment sourcing
Conventional investment property guidelines generally prohibit borrowed funds, such as a HELOC, being used as a down payment. This prohibition catches many investors off guard and can easily derail your investment strategy.
Fortunately, says Kuclo, “The workaround most experienced lenders and borrowers use is seasoning: draw the HELOC, let those funds sit in your account for at least 60 days, and by the time you apply for the investment mortgage, they appear as liquid assets rather than fresh borrowed funds. Transparency and timing are everything here — coordinate closely with both your HELOC lender and your investment property lender before you make any moves, because the sequence in which these events happen determines whether you sail through or stall.”
DTI stacking
When calculating DTI, lenders typically factor 1% of your outstanding HELOC balance into your monthly debt payments, regardless of what your actual minimum payments are. When you add a primary mortgage and the new investment mortgage on top of it, your DTI can start to balloon.
“The DTI math with three obligations stacked can get uncomfortable fast," says Kuclo. "Imagine a primary mortgage at $2,400/month, a HELOC interest-only payment on an $80,000 draw at roughly $550/month, and a new investment mortgage at $1,600/month; that's $4,550 in housing debt before you even get to car payments, student loans, or anything else.”
Fortunately, most lenders will credit 75% of projected or documented rental income to offset your investment mortgage payments. Plus, you can often pay off your HELOC with your new investment property mortgage, allowing lenders to factor it out of your DTI.
“The best news I can give you is that if you are going to pay off your HELOC balance as a condition of your investment property mortgage, most lenders will not use it in your DTI calculation," says Cabrera. "The place where investment property investors get into trouble is when they choose to leave their HELOC balance outstanding, meaning they are going to continue to carry the outstanding balance on their HELOC after they close their investment property mortgage.”
Other ways to fund an investment property
A HELOC is far from the only way to fund an investment property. Consider these alternative funding sources in case a HELOC doesn’t make sense for your situation.
Home equity loan
With a home equity loan you get a lump sum amount at a fixed rate, providing far more predictability than a HELOC would. However, the main downside is that interest accrues on the full amount rather than on the funds you actually need, leading to high interest payments upfront.
Plus, a home equity loan comes with many of the same risks of a HELOC. You’ll still be using your primary residence as collateral, which can expose you to foreclosure if your investment doesn’t generate the cash flow you were expecting.
Cash-out refinance
With a cash-out refinance you replace your existing mortgage with a new, larger one. That way, you can use the difference to put more down on your investment mortgage. If your existing rate is near or above today’s market rates, a cash-out refinance can make sense.
The problem is that interest rates today are high, so cash-out refinancing rarely makes sense. In fact, 85% of homeowners have locked in interest rates of under 5%, meaning that cash-out refinancing will end up increasing your monthly payments for most homeowners.[1]
DSCR loan
A Debt Service Coverage Ratio (DSRC) loan is a special type of loan that takes into account your rental property’s projected income instead of your personal income. A DSCR loan doesn’t require home equity for collateral, meaning your primary residence is generally safe in case of financial difficulties and your equity is untouched.
Plus, a DSCR loan is useful for self-employed borrowers who don’t have a traditional income source or those whose tax returns show paper losses because of depreciation. If your DTI makes a HELOC-funded strategy harder to qualify for, then a DSCR loan may be a better alternative.
Commercial line of credit
If you hold your properties in an LLC, a commercial line of credit may be a better funding source than relying on your personal home equity. Using a commercial line of credit helps avoid some of the complexities that otherwise emerge when trying to underwrite a mortgage for an LLC.
However, a commercial line of credit comes with different terms and requirements that you’ll have to meet. Plus, they aren’t usually offered by residential lenders, which will limit your ability to shop around. You should talk with a loan officer to decide whether this product is right for your situation.
What to consider before using a HELOC to buy an investment property
- Make sure you have enough equity to work with. You don’t want to be overleveraged because of a lack of remaining equity. A HELOC draw should leave your primary home’s CLTV at or below 80%. If you’re uncomfortable with where a 10% decline in your home’s value would leave you, then a HELOC is probably unsuitable.
- Run a realistic cash flow scenario. Add up how much you expect to pay each month for your HELOC, investment mortgage, taxes, insurance, and maintenance. Be sure to factor in at least one to two months of vacancy. The rent must be able to cover the combined costs, including when you’re struggling to find tenants.
- Know your exit strategy. A HELOC is a short-term bridge, not a long-term solution. “If you're using your HELOC on an investment property that you're going to own long-term, you should be using that as a tool to get your investment property, then refinancing that into a fixed-rate investment loan," advises Cabrera, That way, your costs are not variable, which is what you want.”
- Consider opening the HELOC before you need it. You’ll usually want to open your HELOC early, even if you don’t need to withdraw any of the funds yet. Opening up a HELOC when you’re making an investment property application can be disruptive as it means a new credit inquiry will appear mid-transaction.
- Keep reserves. Lenders typically want to see six months of reserves to cover expenses related to your investment property. Remember that you’ll also need to cover expenses for your primary residence, so you’ll want reserves for both. Also, avoid withdrawing your full HELOC amount right away. You’ll need room for repairs, other opportunities, or unexpected costs.
- Cast a wide net when shopping for lenders. Don’t limit yourself to large retail banks when searching for HELOCs. Many credit unions and smaller community banks offer more competitive rates. When comparing lenders, look beyond the headline rate. Mandatory draws at closing, minimum line amounts, and prepayment penalties are extremely important and can have a big impact on your cash flow.
Connect with a loan officer to make a plan
Whether you’re thinking of purchasing an investment property today or further down the road, talking to a loan officer now can help. An experienced loan officer can look at your current financial profile and advise you on your loan options.
At Best Interest Financial, we provide personalized, white-glove service that big-box and automated lenders can’t. With over 80 years of combined experience and billions in closed loans, our loan officers have the expertise to help identify creative financing possibilities that others miss.
No matter what your timeline is, we can help you develop a strategy to reach your goals and get you on the path to owning your next home. Get a free, 60-second quote from Best Interest today to learn more.
FAQ
Can I use a HELOC as a down payment on an investment property?
Yes, but you’ll need to take timing into consideration. Investment property guidelines usually prohibit borrowed funds, such as a HELOC, as a down payment. To get around this, you’ll need to use what’s called seasoning, which is drawing funds at least 60 days before closing so that they count as liquid assets when applying for an investment mortgage. Confirm with your lender their seasoning requirements.
How much equity do I need to use a HELOC to buy a rental property?
You’ll usually need to retain at least 15-20% equity (or 80-85% LTV) after withdrawing from your HELOC. Ideally, you’ll want to maintain a CLTV of under 80%, which will give you flexibility if home values come down while you’re trying to maintain a HELOC and mortgage.
Is it a good idea to use home equity to buy a rental property?
It depends on your situation. If you have a stable income, significant equity, and a reliable cash flow plan, then using equity to buy a rental property can make sense. However, doing this comes with risks, such as variable interest rates, exposing your home as collateral, and maintaining dual leverage. You should talk to a loan officer to decide whether using home equity to buy a rental property makes sense for you.