As we’ve written before, there are many different ways to secure real estate financing.
You can work with a bank, network with other investors and investment clubs, seek out hard money lenders or work out an owner financing arrangement.
Yet there’s one more way to finance your real estate deals. You might be sitting in it right now.
We’re talking about your home, of course.
In this blog post, we’ll look at how home equity loans and home equity lines of credit may be able to help you fund your next investment project.
What is a home equity loan?
A home equity loan – or HEL – is a loan on the equity you’ve built up on your property. You can calculate your home equity by subtracting the amount of money left on your mortgage from the value of your property.
These loans will normally come with a fixed interest rate. That means you’ll make the same payment each month, making it easier for you to budget.
The money you get from a home equity loan is a one-time lump sum payment, making it a good source of real estate financing for major projects.
The drawback to using a HEL is that tapping into all the equity in your home all at once can come back to haunt you if your local property values begin to diminish.
That’s to say nothing of the real risk: you’ve chosen to use your home as collateral. If you default on the home equity loan payments, the lender can foreclose on your property.
What is a home equity line of credit?
Also referred to as a HELOC, a home equity line of credit gives you a source of funds that you can dip into when necessary. It’s often compared to a credit card: borrowers have a set amount of money available to borrow and repay but can draw what they need as needed.
Borrowers must make monthly payments to repay the loan, but because you may not be borrowing on the entire amount the lender offers, your payments will only reflect how much you’ve withdrawn.
With a home equity line of credit, you’ll only pay interest on the amount you’ve withdrawn and the interest rate will usually be lower than what you’d see with a HEL.
The advantages to using a HELOC are that you’ll pay interest compounded only on the money you draw instead of the total available equity, while some loans may even let you make interest-only payments throughout the draw period.
The downside is that changing interest rates can cause you to make higher payments. It’s also easy to spend more than you anticipated if you aren’t disciplined.
Using HELs and HELOCs as a source of real estate financing
A home equity loan can provide an easy source of cash for investors who need real estate financing, particularly for rental properties.
With a home equity loan on your primary residence, you can circumvent some of the costs you’d need to cover with a traditional mortgage for a rental property.
And as your rental properties begin to generate rental income, you can use that money to pay off the home equity loan.
Home equity loans tend to have lower closing costs and a quick turnaround time, and the interest on a home equity loan is tax deductible.
Getting a home equity line of credit for an investment property might be trickier. Lenders can be reluctant to offer them because of the risk involved. If the borrower hits a financial rough patch, they’ll be more likely to neglect repaying the loan as they try to keep up with their initial mortgage.
One of the best ways to find a lender willing to float a HELOC for an investment property is by working with local real estate investment groups who can offer recommendations.
If you’re in the Philadelphia area and interested in finding such a lender – or just learning more about real estate financing – DIG can help.
We are the Diversified Real Estate Investor Group and we’ve spent more than four decades connecting local investors with other professionals in the real estate business. Come to our next meeting to see how we can help you fund your next project.