Can You Take Out a Line of Equity on a Rental?
Financial institutions often allow people to take out home equity lines of credit (HELOCs) on their primary homes, secondary residences and rental properties. Underwriting guidelines are usually much stricter for lines of credit on rental homes than primary residences because people are more likely to default on loans not secured by their primary home.
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Features
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Home equity lines of credit work similarly to credit cards. The borrower has access to a revolving credit line and receives monthly bills requiring interest-only minimum payments. Banks usually waive closing costs on HELOCs if the borrower agrees to take an immediate draw on the line of credit of $10,000 or more. Banks may require borrowers to maintain a balance for a certain number of years, although financial institutions usually only require a balance during the first 90 days. Borrowers can use and pay off the HELOC multiple times.
Time Frame
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Generally, HELOCs remain in place for up to 35 years. Normally, during the first 10 to 20 years of the term, borrowers can actively use the revolving line of credit. At the end of the initial term, most lenders convert any remaining balance below $20,000 into an amortizing 10-year fixed-interest home loan. Balances in excess of $20,000 are usually converted into 15-year fixed-interest home loans. Borrowers receive their first HELOC statement between 30 and 45 days after the loan closing. Thereafter, bills are received on a monthly basis.
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Benefits
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People who own rental properties often prefer to take out HELOCs on a rental home rather than on their primary residence. They may not want to lose equity they've built up in their primary home or risk their primary home if they ever fall behind on payments. Generally, people use funds from the HELOC to maintain rental properties, and for convenience's sake, they prefer to have their line attached to the property the funds are being used for.
Misconceptions
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Borrowers may not realize that HELOCs are mortgages. If the borrower defaults on a mortgage and it goes into foreclosure, a report detailing the event remains on the borrower's credit bureau report for up to seven years. Additionally, borrowers may believe that if they rent out a house for more than their monthly mortgage payment, their debt-to-income ratio (DTI) meets bank underwriting requirements. In reality, banks limit borrowers to DTI ratios below 50 percent, meaning someone would have to charge twice as much for rent as he pays on the HELOC to prevent the new line from increasing the DTI ratio.
Warning
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To mitigate the risk associated with lending against nonprimary residences, banks normally charge significantly higher interest rates for HELOCs secured by rental properties. HELOC rates are based upon the prime rate and increase in conjunction with this rate. In the past, the prime rate rose as high as 20 percent; HELOCs often have rates set at 2 or 3 percent above prime. Borrowers could see monthly payments rapidly rising if interest rates rise. Rates on rentals rise more quickly than on more conservatively priced HELOCs on primary homes .
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