If you want to purchase real estate, you might find yourself hitting a roadblock before you even begin. Purchasing an investment property requires a down payment and many people don’t just have that much money lying around.
Luckily, homeowners may have that money hidden away within the value of their house. Investors who want a large amount of cash can take out a HELOC and get the money they need for a down payment.
Interested in a HELOC? Read on.
What is HELOC?
Aspiring investors who already own real estate may be able to take out a home equity line of credit (HELOC) to purchase an investment property. This type of loan gives homeowners quite a bit of cash based on how much equity they have.
People often use a HELOC as a second mortgage to consolidate debt, or to make renovations on their current home. Before you take out a HELOC, consider all of your options and how a HELOC may affect your credit score.
How much can you take out through a HELOC?
It all depends on the equity of your home! Say your home is worth $200,000 and you have already paid off $100,000. You have $100,000 in equity. Most lenders will allow you to borrow up to 80% of the home’s equity - in this case, you would be able to borrow up to $80,000.
Lenders do not deliver all of this cash to you at once. A HELOC works like a credit card or a checkbook; once you hit your limit, you are cut off.
If you want to spend $80,000 on a down payment for your next investment property, go for it. If the down payment is only $20,000, you can spend that money and never touch your HELOC again.
Homeowners can also use their HELOC for multiple purchase. If you want to take out $20,000 for a down payment and spend another $10,000 to pay off student loan debt, you have that option...just as long as you don’t hit your credit limit.
What To Consider Before Taking Out a HELOC
A Payment Plan
HELOCs are just like any other investment strategy - they come with risks. When you take out money against your house, you essentially gamble your house. If you are prepared to pay back the HELOC, however, you shouldn’t have to worry.
Before you take out a HELOC, it is important to understand two things: the draw period and the repayment period.
The draw period is the time that you are allowed to take out money. This clock doesn’t tick so fast; usually draw periods last between 5 and 10 years. During this time, you will only have to pay interest on the amount of money that you took out.
Once the draw period is over, the repayment period begins. Borrowers will have to pay back the outstanding principal and interest.
Borrowers can use repayment calculators to estimate how much they will need to pay each month, but consider the loan terms that come with a HELOC. Lenders typically charge an adjustable interest rate that could increase during the draw period or the repayment period. If you want to play things on the safe side, consider changes and interest rate increases as you calculate how much money you want to take out through the HELOC.
Your Credit Score
Borrowers will typically need a credit score above 620 to qualify for a HELOC. Once the lender approves your application, the HELOC will appear on your credit score. If you consistently make payments, your credit score will increase. If you don’t, you will only make things harder for yourself in the long run.
Your credit score will also consider how much money you take out from the HELOC. Your credit score will increase if you take out less than 30% of your spending limit. (So, if we consider the example from earlier, your credit score would increase if you only took out $24,000.)
Ready to apply for your first HELOC?
If you are ready to use a home equity line of credit to purchase your next investment property, you can start looking for lenders. If you still want to explore your options for gathering capital and investing in real estate, consider looking into home equity loans, a cash-out refinance, and other forms of financing.