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?
- 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 it does appear that the wild growth rate of the last several years is starting to slow down as interest rates are rising quickly. 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.