Should You Take Out a Home Equity Loan on a Rental Property? (2024 Guide) (2024)

FAQs

Can you deduct a home equity loan on rental property? ›

The interest you pay on your rental property home equity loan may be tax deductible, which can help reduce your taxable income. However, to qualify for this tax deduction you must use the loan to improve the property.

Despite their advantages, home equity loans come with risks: You could lose your home if you miss payments, end up owing more than your home's worth and harm your credit score.

If you own a home and you need to borrow money, a home equity loan may be an option worth considering. A home equity loan can help you get cash for home improvements, debt consolidation or other major expenses using the value you've built up in your home as a financial resource.

High Debt-to-Income Ratio

If your debt-to-income ratio is too high, lenders may be concerned about your ability to make your payments. Many lenders look for a debt-to-income ratio of 43 percent or lower.

Cash-out refinance on a rental property turns accrued equity into cash for reinvestment. Rental property refinance loans may have slightly higher interest rates, fees, and lower loan-to-value ratios. Obtaining a cash-out refinance rental property loan can be a good way to raise capital for additional investments.

If you receive rental income from the rental of a dwelling unit, there are certain rental expenses you may deduct on your tax return. These expenses may include mortgage interest, property tax, operating expenses, depreciation, and repairs.

Equity Financing also has some disadvantages as compared to other methods of raising capital, including: The company gives up a portion of ownership. Leaders may be forced to consult with investors when making a decision. Equity typically costs more than debt financing due to higher risk.

Though taking out a home equity loan can cause your credit score to drop, the impact is usually fairly small, and you can improve your score over time by managing your credit responsibly.

Using a HELOC for debt consolidation can open up the doors to lower interest rates and streamlined payments. But it also carries risks. With a HELOC, your home is used as collateral, and you could lose it to foreclosure if you fail to make your payments.

Is now a bad time for a HELOC? ›

Is it a bad time to get a HELOC? No. In fact, it could be a very good time. While HELOC rates are higher than they used to be, they are at historically normal levels.

A home equity loan is a better option than a home equity line of credit (HELOC) if: You know the exact amount that you need for a fixed expense. You want to consolidate debt but don't want to access a new credit line and risk creating more debt.

Don't: Use it to Pay for Vacations, Basic Expenses, or Luxury Items. You have worked hard to create the equity you have in your home. Avoid using it on anything that doesn't help improve your financial position in the long run.

Home Equity Loan Disadvantages

Higher Interest Rate Than a HELOC: Home equity loans tend to have a higher interest rate than home equity lines of credit, so you may pay more interest over the life of the loan. Your Home Will Be Used As Collateral: Failure to make on-time monthly payments will hurt your credit score.

Key takeaways. The benefits of a home equity loan include consistent monthly payments, lower interest rates, long repayment timelines and a possible tax deduction. The downsides of a home equity loan include a significant equity requirement and the potential to lose your house or owe more than your home is worth.

Requirements to get a HELOC on investment property

This is measured by the loan-to-value (LTV) ratio. Typically, a lender will want an LTV in the 75% to 80% range for an investment property. This means that any outstanding loans on the property can't exceed 75% to 80% of the value of the property.

Rental property owners can deduct the costs of owning, maintaining, and operating the property. Only the value of the buildings can be depreciated. You can't depreciate the land since it never gets "used up."

With a personal home equity loan, for example, you may be able to borrow up to 80% (or even 100%) of your home's value, less the amount of any mortgage. If you're looking for a home equity loan on an investment property, however, you may only be able to borrow up to 60% to 75% of your property's value.

A frequently asked question is whether investors can deduct the costs of obtaining a loan or refinancing the mortgage. While refinance closing costs on rental property are not deductible in the year you refinance, they can be amortized and deducted over the life of the loan in a process known as depreciation.