September 26, 2014 by Leave a comment

The good news is that you can take out a home equity line of credit, better known as a HELOC, on a rental property. Most lenders will give you a HELOC – if your credit is good – on rental properties that have up to four units.

And lenders don’t care what you’ll use your line of credit for. If you want to borrow against the HELOC for a down payment on a second rental property or permanent residence, that’s OK.

The challenge, though, lies in the amount of equity you have in your rental property. You’ll need enough to allow for a HELOC. If you’ve purchased the rental property recently, you might not have made enough payments to create enough equity.

And if your rental property’s value has gone down since you’ve bought it? Then your equity might be even lower than you expect.

Here’s an example: Say you purchased your rental property in 2007 for $300,000. You came up with a down payment of $60,000, meaning that you took out a mortgage loan for $240,000. If you’ve since paid off $60,000 worth of principal on that $240,000 loan, your new principal balance on your loan is $180,000.

But what is your equity? If your home is still valued at $300,000, your equity will be $120,000, your home’s value minus what you owe on your mortgage loan’s principal balance. But if your home lost value since you bought it, your equity will be lower. If your rental property is now worth $250,000, your equity will be just $70,000 ($250,000 – $180,000).

When lenders approve you for a HELOC, the size of your credit line will usually be a percentage of your equity. If your equity is at $120,000, a lender might approve you for a line of credit of $80,000. If your equity is only $70,000, though, your lender might approve you for a line of credit of just $40,000.

So when deciding whether it’s time to apply for a HELOC on a rental property, first consider your equity level. If it’s too low, taking out a HELOC might not make sense.

Carter Wessman is originally from the charming town of Norfolk, Massachusetts. When he isn’t busy writing about mortgage related topics, you can find him playing table tennis, or jamming on his bass guitar.

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