Today it can be difficult to secure money to buy a rental home. Lenders tightened their restrictions in order to avoid too many defaults. But that leaves many would-be investors without the properties they want to invest in to make them profitable.
One way you can get around the tight mortgage restrictions is with a home equity loan on your principal residence property. If you have enough equity in the home, you can take a loan on it and use those funds to buy your investment home.
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Is this a smart idea, though? We take a look below.
The Benefits
There are many positives of using a home equity loan to buy a rental home:
- Flexibility with the funds – If you obtain a home equity line of credit, you are free to do what you want with the funds. Let’s say you only need a portion of the funds to buy the home. If you have money remaining, you can use it to make repairs or fix up the home to help you make an even larger profit when you rent it out or sell it.
- Tax deduction – You may be eligible to deduct the interest on the first $100,000 that you borrow on your home equity loan.
The Downsides
Of course, there is always a downside to every positive:
- Your principal residence is at risk – If your venture into investment real estate is a flop, you put your primary residence at risk if you can’t pay the home equity loan back. Make sure you can afford the payment for the second loan without the income from the investment property.
- Higher interest rate – Depending on the type of second lien you take on your property, you could potentially pay higher interest rates, costing you more for the loan in the long run. This could eat away at your profits as you enter investment real estate.
- A risky investment – Taking equity out of your home is like taking money out of a safe investment and putting it into something risky. Of course, taking a risk could mean higher profits. It could also mean that you lose it all. Making sure you do your research will help you determine if you are making a right choice.
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Paying for the Rental Home
What you really have to consider is how you will pay for the entire rental home. Do you have enough equity in your home to cover the full purchase price? If not, will you use the home equity loan to cover the down payment and then take a standard mortgage on the investment property? If so, you’ll have a lot of loans to handle and keep up with – are you up for the task?
You must ask yourself, what are my plans for the home? Are you going to rent it out? If so, will the rent cover the cost of the mortgage on the investment property plus your home equity loan? Do you have a backup plan should the tenants default on their rent?
These are the questions you must ask yourself to determine if taking a home equity loan is smart when buying a rental home. In a perfect world, it would be a great situation as it allows you to get into real estate investments. However, in reality, everything could blow up in your face and you could be without the means to pay the loan back which puts your home at risk. Give the situation careful thought so that you are able to determine what’s the right choice for you.
