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The average American mortgage holder currently has $299,000 in equity, $193,000 that’s accessible, according to ICE’s February 2024 Mortgage Monitor Report. If you’re sitting on a sizeable amount and want to use it to buy an investment property, it could be a good idea but there are a few important pros and cons to consider first.
On the one hand, home equity loans and home equity lines of credit (HELOCs) come with relatively low interest rates and can offer a large amount of cash that you can use for a down payment. On the other hand, tapping into your home equity means pledging your property as collateral which puts it at risk. So, when can it make sense? We asked three financial experts to weigh in.
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Should you use a home equity loan to buy an investment property?
Here’s when you should – and shouldn’t – use your home equity to buy an investment property, according to the experts we consulted.
When you should use home equity to buy an investment property
“This is a strategy that we incorporate relatively often,” says Mason Whitehead, the branch manager at Churchill Mortgage. Whitehead explains that using your home equity for real estate investments helps you maintain good liquidity because you won’t have to use your personal savings or cash-out investments. He adds that HELOCs can usually be done fast, often closing within two weeks.
Brie Schmidt, the managing broker at Second City Real Estate, also says it can be a good idea but adds that it depends on a few key factors. “To determine if it makes sense, you need to consider the interest rate on the HELOC and the rate of return you can get from the investment property,” said Schmidt. By running the numbers, you can figure out if it’ll be a profitable move or not.
You may also want to consider waiting to tap into your equity until you have at least one investment property. “My business partner took out an equity loan on his three-unit investment property and used that money as a down payment to purchase a nine-unit rental property. This is an incredibly wise decision as an investor because it greatly increases wealth while keeping a personal residence safe,” says Ryan David, the owner and lead investor of We Buy Houses in Pennsylvania.
Learn more about your home equity loan options here.
When you shouldn’t use home equity to buy an investment property
While Whitehead says that tapping into your home equity can be a helpful way to buy an investment property, he also warns that it can be risky.
“Taking out a HELOC increases your monthly debt payments and obligations,” he says. He explains that a job loss, income loss, or negative movement in the market could result in a “domino” effect that causes you to lose multiple properties.
David adds that he doesn’t think homeowners should borrow against the home equity in their personal residences, period. “Everyone needs a place to live and you don’t want to run the risk of putting you and your family on the streets,” he explains.
The bottom line
Whether or not you should tap into your home equity to invest in another property will depend on your situation and risk tolerance. Whitehead explains that it’s important to run through different potential worst-case scenarios before taking out any debt to ensure you’re in a good position to do so.
Further, calculate the cost versus the potential returns. “If the HELOC has a rate of 7.5% the cash-on-cash return of the investment must be greater than 7.5% to make sense,” said Schmidt, “If the cash-on-cash return is less than 7.5% it will cost you more to borrow the money than you will make on the investment, and that’s probably not the right investment choice.”