Have you ever wondered how successful real estate investors seem to acquire properties so quickly? The answer is usually related to “OPM”, or Other People’s Money. In today’s post, we’ll discuss how I’ve used a common form of OPM, a Home Equity Line of Credit or HELOC to buy investment property.
The best part is that you can use and repeat this strategy to acquire multiple properties. On three separate occasions, my wife and I successfully used a HELOC to buy investment property.
Besides acquiring properties, as a real estate investor, you can also use a HELOC to update a property. My wife and I have done both. We’ve used HELOCs to help with the initial downpayment to acquire properties. We’ve also used HELOCs to improve properties after we’ve purchased them to increase its value.
Read on to learn what a HELOC is and how to use a HELOC to buy investment property.
What is a HELOC?
A Home Equity Line of Credit (HELOC) allows you to borrow money, in the form of a loan, against the equity in your home. Equity is the value of your home less what you owe on a mortgage.
Think of a HELOC as a second mortgage on your property that works like a credit card. That means you will be charged interest when you use your HELOC funds.
Just like with a primary mortgage, when you open a HELOC, the bank is protected by the equity in your home.
Just like a credit card, you can choose when and how to use a HELOC. And, you can use your HELOC over and over again, as long as you pay down the balance. Use it, pay it off, use it again. This is what my wife and I have done.
Of course, this is one of the best parts about HELOCs. Whether you want to use a HELOC to buy an investment property, or for any other purpose, you can tap the funds repeatedly and don’t get charged any interest until you use them.
This point is worth repeating. You can open a HELOC and not use it right away. You won’t be charged interest while you wait for an opportunity to present itself.
That opportunity might be using your HELOC to buy investment property.
Or, it might mean using your HELOC to renovate your home or buy a car. This is what my wife and I did recently. When we bought a new car last year, we decided to use our HELOC funds instead of taking out a new auto loan.
Keep in mind that when you decide to use your HELOC, you will be charged interest until you pay it back, just like a credit card. This is a major consideration to keep in mind if you’re thinking about using a HELOC to buy an investment property.
To recap, a HELOC is really just a form of credit card, available to you for a set period of time, secured by the equity in your home.
You can use those HELOC funds for any purpose. You can choose to use your HELOC to buy investment property, renovate your home, buy a car, or for pretty much any other purpose.
What to know about paying off a HELOC.
If this all sounds too good to be true, don’t forget that you do have to pay off your HELOC, with interest. Just like any other debt, whether it’s Good Debt or Bad Debt, a HELOC needs to be paid off.
HELOCs are generally broken out into two phases, the “draw period” and the “repayment period.”
The first phase is known as the borrowing period, or draw period. You can continue to use your HELOC funds for the duration of the draw period. Most HELOCs have a draw period of 10 years.
During the draw period, your loan balance will accrue interest. Generally, you are required to make minimum payments during the draw period.
These payments are usually referred to as “interest only” payments. This means you must pay the interest accrued during the previous month, but you don’t have to pay down the principle owed.
At the close of the draw period, the repayment period begins. During the repayment period, you can no longer borrow from your HELOC.
The repayment period typically lasts 10 or 20 years. Your lender will set a schedule for monthly payments to pay off the balance in full, similar to a mortgage.
Four advantages to using a HELOC to buy investment property.
Here are the four main reasons why I’ve used a HELOC to buy investment property. These same advantages apply to any other major purchase.
1. You can use a HELOC as you would use cash, including for a downpayment.
Once your HELOC is open, you can use the funds as you would cash. All you need to do is link your HELOC account to your primary checking account. You can make transfers into your checking account, as needed, up to your full HELOC credit limit.
With a HELOC, once the transfer hits your checking account, you can spend that money just as you would any other money.
This is a huge advantage if you want to use a HELOC to buy investment property.
That’s because lenders heavily scrutinize where you are getting the funds you plan to use to close on a property. HELOC funds are almost always allowed to be used for a downpayment.
On the other hand, cash advances from credit cards are typically not allowed for a downpayment on a conventional loans.
2. HELOCs charge lower interest rates.
The interest rate charged on HELOCs will typically be lower than the interest rate charged by credit cards and other personal loans.
Interest rates on HELOCs are similar to prevailing mortgage rates, but typically charge about 1-2% more. This is to compensate the HELOC lender for the added risk of being the second mortgage on a property.
According to Bankrate, here are the current average interest rates:
As you can see, if you need to borrow money for any reason, using a HELOC usually gives you the best rate. This is a major reason why people generally use HELOCs.
It’s also the primary reason why I have used a HELOC to buy investment property.
Keep in mind that HELOCs generally charge a variable interest rate that may change monthly depending on market conditions outside your control. This is again to protect the HELOC lender, and is a factor to consider before you use your HELOC funds.
In fact, this is one of the key risks with using HELOCs. You may apply for a HELOC when interest rates are low, but that can change. You may be faced with a significantly higher rate when you pay off the balance.
From a real estate investor’s perspective, a higher interest rate may end up eating into all of your cashflow. Before using a HELOC to buy investment property, make sure the cashflow on the property can cover the higher loan payments.
3. You only pay interest on HELOCs during the draw period.
As discussed above, you typically only have to pay the interest on a HELOC during the draw period. That means your monthly payment is lower. As long as you make the minimum payment, the overall balance will not grow month to month.
Then, during the repayment period, you have 10 to 20 years to pay off the balance. This lengthy period helps spread out the balance over time, which keeps the required payment lower each month. This long payoff period is extremely beneficial when paying off larger purchases, such as a home renovation.
This is also another key reason why a real estate investor would use a HELOC to buy investment property.
Spreading out the payments over the long term, and only paying interest during the draw period, means more monthly cashflow. Some real estate investors think differently, but to me, cashflow is king.
4. You may have access to a larger sum with a HELOC.
Because a HELOC is secured by the equity in your home, it’s likely you will be eligible for a larger sum than a typical credit card or other personal loan.
While credit cards also allow cash advances, they are typically capped at a relatively low amount and come with higher interest rates.
A larger available balance comes in handy when you want to use a HELOC to buy investment property.
For conventional loans, you’ll typically need 20-25% of the purchase price as a downpayment. That is a lot of money to come up with on your own, even if you are great at fueling your savings.
The same is true for funding any other major purchase. For example, just the other day, I spoke to a friend who opened up 12 different credit cards to launch his software business.
If he had access to a HELOC, he would not have needed 12 separate credit accounts. The HELOC would have provided him enough funding.
How I’ve used HELOCs to scale my real estate portfolio.
Using HELOCs can be an effective way to scale your real estate portfolio.
As mentioned above, you can use your HELOC for a downpayment on another investment property.
This is one of the ways my wife and I scaled our real estate portfolio. We primarily invest in an area of Chicago where properties can get expensive. The same can be said about our vacation rental in Colorado.
Coming up with a full downpayment in these markets on our own would take years of savings. We’ve made the choice to take on additional debt and added risk to scale more quickly.
We purchased our first investment property in 2018. After making some improvements and paying down the mortgage, we applied for a HELOC in 2020. We then used those HELOC funds to help with the downpayment for our Colorado ski rental in 2021.
After a couple years of unexpected appreciation on our ski rental, we took out a HELOC on that property in 2022.
We then used that HELOC to help purchase a third rental property in Chicago in 2022 and our primary home in 2024.
As you can see, we’ve used our equity gains in our earlier properties to take out HELOCs to help acquire additional properties.
Along the way, we have worked on paying down the balances of each of those HELOCs. This way, we reduced our debt and increased our net worth. We can also now repeat the process and again use a HELOC to buy investment property.
Besides a downpayment, real estate investors can use HELOC funds to make improvements to their properties.
Real estate investors also use HELOC funds for improvements to their properties. These improvements can lead to equity gains through appreciation and also more monthly cashflow.
We’ve used HELOCs in this way on multiple occasions. For example, we used our HELOC to install washers and dryers into three of our apartments.
We then paid off the HELOC balance with the increased rental income generated by those three improved apartments.
Don’t ignore the biggest risk of using a HELOC to buy investment property.
With all the advantages of HELOCs, there is one major risk that cannot be ignored. This single risk is so important that is should outweigh all of the advantages for most people.
HELOC equals debt.
Like with all debt, if you abuse the privilege, you are going to get yourself in trouble.
This is why Dave Ramsay is adamant that debt should not be used as a tool to build wealth.
In his bestselling book, The Total Money Makeover, Ramsey walks you through how to build wealth without relying on debt.
If you decide to tap your HELOC funds, remember that the loan is tied to the equity in your home. If you fail to comply with the loan terms, your home is at stake.
That’s a huge risk.
Before you consider using a HELOC, be sure to have a plan in place for paying back the loan. This is where your Budget After Thinking can really help.
I would not use a HELOC as a beginner investor.
While there are upsides to using HELOCs, it is a potentially risky strategy that I would not feel comfortable with as a beginner investor.
I say that for good reason.
When you hear HELOC, you should immediately think about debt. For many of us, debt is problematic and leads to negative emotions.
I’ve experienced these negative emotions associated with debt. I only got comfortable with taking on debt as I learned to trust myself again with the responsibility.
While I’ve used HELOCs to scale my real estate portfolio, my primary money goal this year is to pay down these HELOCs. I’m tired of having those debt balances hanging over my head.
If you have proven to yourself that you can responsibly handle debt, using a HELOC may be a worthwhile strategy.
By responsible with debt, I mean:
- You pay your credit card, and all other bills, in full every month.
- You’ve never missed a payment.
- You’ve proven you can control your spending.
- You fuel your Later Money every month.
- You understand the risk of taking on additional debt.
- You’ve thought and talked about it with your inner circle.
If you have satisfied all of the above, you can then make an informed decision about using debt to scale your real estate portfolio.
How do you apply for a HELOC?
Applying for a HELOC is just like applying for a mortgage. The bank will review your finances and determine if it will lend you money against the equity in your home.
If you’ve ever applied for a mortgage, you know this is not a fun process.
The key to qualifying for a HELOC is that your home equity needs to have grown in value, either by paying down your primary mortgage or through appreciation.
Let’s look at an example of using a HELOC to buy investment property.
Note, you’ll never have to do this math yourself. This is for illustration purposes in case you want to estimate the amount you may be eligible for before you start the application process.
For easy math, we’ll make some assumptions in this example. Always confer with your mortgage broker or lender for precise calculations.
In this example, let’s say you bought a home five years ago for $500,000.
- You put 20% down ($100,000) when you bought the home, so your original mortgage was for $400,000. This means your equity in the home when you bought it was $100,000.
- For the past five years, you’ve paid down the principle on your mortgage every month. For easy math, let’s assume your remaining mortgage is now $350,000. Because you paid down $50,000 of the mortgage, your equity has increased by $50,000.
- Not only have you been paying down the mortgage for five years, your home has also appreciated in value and is now worth $600,000. That’s another $100,000 in equity you now have in your home.
Add it all up and you started with $100,000 in equity (your original downpayment) and now have $250,000 in equity.
This is because you have paid the mortgage down every month and your home has appreciated in value.
In this scenario, you may be eligible for a HELOC to buy an investment property.
How do lenders calculate the amount of your HELOC?
Each bank may have different standards for qualification and how much they will lend you. Generally, banks will use a metric called Loan-to-value ratio to calculate the amount of your HELOC.
What is Loan-to-value ratio?
Loan-to-value ratio is a complicated name for an easy math formula:
LTVratio = Mortgage amount / Property value.
In our scenario, your current mortgage amount is $350,000. Your property value is $600,000.
So, your LTVratio is .5833 ($350,000 / $600,000). In terms of percentage, that’s approximately 58%.
A typical HELOC lender will allow you to borrow up to a combined LTVratio of 70%.
That means your existing mortgage plus the HELOC can only add up to 70% of the value of your home.
The bank does this to protect itself by requiring you to maintain 30% equity in your home.
To carry out our example, using a combined LTVratio of 70%, you may be eligible for a HELOC of $70,000:
- Value of home = $600,000.
- First mortgage = $350,000 (approx. 58%)
- HELOC = $70,000 (approx. 12% of value of home)
- Combined mortgage + HELOC= $420,000 (70% of home’s value).
- Remaining equity in home = $180,000 (30% of home’s value).
Again, you don’t need to do this math yourself, but it’s helpful if you want to understand what size HELOC you may be eligible for before starting the process with lenders.
Have you used a HELOC to buy investment property?
Using a HELOC to buy investment property can be an effective strategy. My wife and I have effectively used this strategy multiple times.
Before you decide to use a HELOC, be sure to understand the risks associated with taking on additional debt.
- Have you used a HELOC to buy investment property before?
- What about using a HELOC for any other purpose?
Tell us about your experience in the comments below.