Investment properties can be a great way to build passive income and diversify your investment portfolio, but breaking into real estate investing takes a large chunk of change. If you don’t have cash lying around and don’t want to wait until you’ve saved it, can you use a home equity loan on an investment property?
Key Takeaways
- Higher interest rates have led to a slight slowing of the housing market.
- A home equity loan risks your home if you can’t pay it back.
- You can make money in real estate in a slower market, but it takes skill.
- Know the risks before you borrow against your house.
Using a Home Equity Loan to Invest in Real Estate
Home equity loan proceeds can be used on anything you choose, including investing in real estate. To use a home equity loan to invest in real estate, you’ll need to have some equity in your existing property, decent credit, and proof of income sufficient to pay back the loan.
Once your home equity loan has closed and you have picked out an investment property, you can use the proceeds from your home equity loan in any way you choose on your investment property, or anything else. The cash is yours to use as you wish after the loan closes.
However, just because you can use your home equity loan to invest in real estate doesn’t mean you should.
Risks of Using a Home Equity Loan to Invest in Real Estate
Using a home equity loan for an investment property carries risks that you must consider before signing up for one.
Home Equity Loan Risks
Home equity loans are loans that allow you to borrow against your home’s equity for a lump-sum payout that you pay back over time with a fixed interest rate and fixed monthly payments. They carry two main risks:
- You could default on your loan and lose your home if you can’t keep up with payments.
- Your home’s value could decrease and you could become underwater on your loans, meaning that you can’t move or sell your home without paying money to your lenders.
Real Estate Investment Risks
Nobody can predict the future of the housing market with 100% accuracy, but as of 2023 the wild growth rate of the previous several years started to slow down as interest rates were rising. Investing in real estate as the market is slowing means that it could be difficult for you to make money in the near future after accounting for closing costs, high interest payments, and any renovation expenses you may have.
While real estate investing has been a relatively easy way for people with even minimal knowledge to have fantastic gains over the last several years, don’t confuse someone else’s luck investing in a hot market with true success. Learning to analyze real estate markets, rental markets, and potential return on investment takes skill and specialized knowledge that many spend decades building.
If you’re looking to invest so you can flip houses, that may be more difficult to currently profit from. If you’re interested in purchasing investment property to rent out to tenants, then you need to be very thorough in your research on the rental market and the rules and regulations in the area in which you’re investing.You should especially familiarize yourself with some of the eviction moratoriums introduced due to the coronavirus pandemic.
Ask yourself how long you can afford to pay the mortgage and a home equity loan on your primary residence in addition to any loans that you may have on the investment property. If you can’t afford to maintain those payments without any rental income for more than a year, then taking out a home equity loan to invest in rental real estate could cause you to lose your home. Make sure that you’re comfortable with that level of risk for the potential reward of passive income before you take out a home equity loan.
Can I get a tax deduction for my home equity loan?
You can only get a tax deduction on the interest portion of your home equity loan on the amount used to buy, build, or substantially improve the borrower’s home on which the home equity loan is based. If you’re using a home equity loan to invest in a separate property, you cannot get a tax deduction.
Is investing in real estate risky?
All investing is risky, but real estate investing carries its own risks. The property in which you’ve invested could decrease in value over time. If you’re investing in property and renting it out, your property could be damaged by tenants or you could face long periods of nonpayment while you go through the expensive process of evicting someone.
Can I use a home equity loan to invest in a real estate investment trust (REIT)?
You can use your home equity loan’s proceeds on anything you like, including investing in a real estate investment trust (REIT). Investing in an REIT can mitigate some of the risks of individual real estate investing, but they have come under recent fire for buying up properties in areas and contributing to the housing crisis. Additionally, eroding your home’s equity to invest carries the risk of foreclosure if you can’t afford to pay back your home equity loan.
Which is better for investing, a home equity loan or a home equity line of credit (HELOC)?
That depends. If you only intend to invest in one property and you know the exact amount needed, then a home equity loan will most likely have a lower interest rate over time than a home equity line of credit (HELOC). If you intend to invest in many properties over time, then a HELOC allows you to pull equity and pay it off multiple times with one product and is more convenient than taking out and paying off multiple home equity loans over the same time period.
The Bottom Line
Investing in real estate was easier to profit from over the last few years than it is likely to be in the future. While someone on TikTok may have doubled their money flipping homes in the last two years, anyone who invested throughout the housing crisis of the early aughts will tell you that it’s not easy in a slower market. Learn as much as you can about real estate investing, and make sure that you have the cash to cover downturns or long periods of zero rental income. If you can’t, then don’t risk the roof over your head with a home equity loan to invest in real estate.
FAQs
You can use the borrowed funds to invest in stocks, bonds, mutual funds, gold or other investment vehicles. This strategy can be effective if you believe that the returns on your investments will outpace the interest on your home equity loan.
What should you not use a home equity loan for? ›
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.
Can I deduct home equity loan interest on rental property? ›
Broadly, if you're making capital improvements to your rental property such as a kitchen remodel, replacing the roof or installing a new HVAC then it's likely you can deduct the interest payments of the HELOC used to fund the cost. You won't be able to deduct the actual expenses incurred, but they can be depreciated.
Can you use home equity for down payment on investment property? ›
Home equity loan proceeds can be used on anything you choose, including investing in real estate. To use a home equity loan to invest in real estate, you'll need to have some equity in your existing property, decent credit, and proof of income sufficient to pay back the loan.
Can you use money from home equity loan for anything? ›
Yes, once you are approved for a home equity loan the money is deposited into your account and you can use the funds for all types of purchases.
Is it a good idea to take equity out of your house to buy another house? ›
Purchasing property with home equity can be cost-effective and make you a more competitive buyer. But it comes with certain risks and downsides: trading assets for debt, losing tax deductions, and risking your home if you miss payments.
What is the downside to a home equity loan? ›
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.
Is it smart to use home equity to pay off debt? ›
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.
Can you pay off a home equity loan early? ›
Borrowers often wonder if they can pay off their home equity line of credit (HELOC) early. The short answer? A resounding yes, because doing so has many benefits. If you're making regular payments on your HELOC, you may be able to pay off your debt sooner, so you're paying less interest over the life of the loan.
Can you write off a home equity loan? ›
The Bottom Line
Borrowers can deduct their home equity loan interest if they use the funds on the home that serves as collateral. So, whether you borrow a home equity loan to help you buy or build a home, or borrow it after you own the home to make improvements, you may deduct the interest.
You can get home equity loans on investment and rental properties, though they may be harder to obtain. To get this type of loan, you'll usually need a stronger-than-average financial profile and substantial assets.
Does a home equity loan count as income? ›
Home equity loan interest, as well as home equity line of credit (HELOC) interest, can be written off your income taxes when you use the money for home improvement purposes, or to purchase or build a new home. You must also itemize your deductions to write off the interest you paid.
Can you take equity out of your house to invest? ›
Tapping into your equity is possible with a home equity loan, home equity line of credit (HELOC), and cash out refinance. You can use your equity to finance investments, including using home equity toward an investment property, stocks, bonds, or mutual funds.
Can I use a HELOC to buy investment property? ›
You're able to use HELOC funds for almost anything, including a down payment on an investment property. However, keep in mind that a HELOC will increase your debt-to-income ratio.
What is a HELOC vs. home equity loan? ›
A home equity loan offers borrowers a lump sum with an interest rate that is fixed, but tends to be higher. HELOCs, on the other hand, offer access to cash on an as-needed basis, but often come with an interest rate that can fluctuate.
Can you do whatever you want with a home equity loan? ›
Yes, you can use the proceeds of a home equity loan or HELOC for anything you want. Whether you should is another matter. In general, tapping home equity is better for major home renovations or other goals that will further your financial life, such as paying off debt.
Can I use equity to buy stocks? ›
Useable equity and investing in shares
Once you've established the amount of useable equity available, you may be able to use these funds to invest into the stock market. The most common types of investments are shares, individual stocks, managed funds, index funds, ETFs and retirement accounts (or superannuation).
How do you build wealth with a HELOC? ›
There are a few different (and simple) ways that you can use a HELOC to build wealth, including:
- Home improvements. One of the most common and practical uses of a HELOC is for home improvements. ...
- Debt consolidation. ...
- Investment opportunities. ...
- Emergency fund. ...
- Education and skill development. ...
- Tax advantages.
Like a home equity loan, a HELOC can be used for anything you want. However, it's best-suited for long-term, ongoing expenses like home renovations, medical bills or even college tuition.
