Like many types of loans that were easy to get years ago during the housing crisis, home equity loans and other loans to cash out on equity in rental properties were relatively easy to get. Now, not so much.
"There's a higher risk with rental properties," says Todd Huettner, president of Huettner Capital, a real estate mortgage brokerage in Denver.
"The financial crisis of 2008 is still very fresh in some people's minds," says Ravi Ramnarain, a certified public accountant in Fort Lauderdale, Fla., who owns rental properties there. "And for that reason banks are cautious about lending people money."
Getting rental income from investment property doesn't preclude an owner from taking out equity in the property and using it to fix up the property and make repairs, just as a homeowner would do with their primary residence. But getting a home equity loan for a rental property can be a bit more difficult with more barriers to overcome. Here are some to consider:
A home equity line of credit, or HELOC, can be appealing for a number of reasons. The rates may be lower than a typical home loan, and the rates are almost always variable. Instead of a lump sum payment, the loan acts as a credit card or checkbook with a 10-year draw period when only interest is paid. The principal and interest are paid within the next 20 years.
The money can be used for anything, including home repairs, renovations, education, emergency savings and medical bills.
Most banks won't offer HELOCs on rental properties, Huettner says, because of the risk with rental properties. They may be more likely to turn customers to a traditional business loan with a higher rate and less favorable terms where the rental property is collateral for the loan, he says.
"It's a situation where the terms and conditions are so hard that people are going to end up going elsewhere," Huettner says.
Instead of a line of credit, lenders may be more likely to do a cash-out refinance than a home equity loan, he says.
To get a HELOC as a rental property owner, you may have to show that you can afford to repay the entire amount, says Lucas Hall, founder of Landlordology.com and an independent landlord for more than 10 years who now owns five rental properties.
That can be done by showing you have more money in the bank than you would for a home equity loan on the home you live in, including several months of mortgage payments for each rental property you own.
Hall has refinanced most of the houses he owns and has taken out lines of credit as a rental property owner, mainly so he can have money available for major repairs.
"It's kind of an emergency fund to my emergency fund," he says.
In determining the ability to repay a HELOC or home equity loan, not all the rental income will be considered income, Ramnarain says, because renters may move out and landlords may have other problems.
For example, 75 percent of $1,000 in rental income would be counted as actual income, or $750, to account for other expenses as a rental property owner, he says.
Tax returns showing income generated from rentals may also be required, Hall says, as will copies of leases to show the rental home will be occupied for awhile and not just a few months.
Some lenders may require rental property owners to have more equity in their property before they approve a HELOC.
"What they really care about is if this property has enough equity for this HELOC," says Hall, adding that the process has been tightened a lot in the past six months.
Hall has refinanced loans and taken out equity so he can buy additional properties, and then refinanced that new property so he can pay back a line of credit on other rental properties, he says.
"I rarely ever use it, unless I have a big purchase coming up, such as another property," he says.
A high loan-to-value ratio, or LTV, is a higher risk to a lender. A higher percentage of a property's cost that needs to be borrowed could make a home equity loan more difficult to get.
Lenders that may approve an LTV of 80 percent for a primary residence may require 70 percent or less LTV for rental property, Huettner says.
An LTV of 75 percent with 25 percent equity may be possible for rental property owners, Ramnarain says. Some homeowners can have LTV of 90 percent on their primary residence, he says.
Low debt-to-income ratio
While a homeowner might be allowed to have more than 40 percent of their income going toward debts and still be approved for a home equity loan, a rental property owner would likely have to lower that debt ratio to 30-35 percent of their income, Ramnarain says.
Refinancing a rental property loan to take cash out for repairs could require a higher interest rate or paying points because of the higher risk of rental property loans, Huettner says.
To keep the interest rate the same as a loan on a primary residence, a borrower may need to pay 2-3 points on the loan, he says. Or they could pay one-fourth to half a point more on the loan's interest rate, he says.
Getting an equity loan on a rental property could require a credit score of 680, compared to 620 for a homeowner who lives in their home, Huettner says.
Banks may be especially vigilant about check that rental property owners have enough insurance, says Ramnarain.
"At the end of the day they're going to see if they're going to get their money" and if you have proper insurance, he says.
Up to 6 rentals
Lenders may cap the number of rental property mortgages at six, Ramnarain says. Four to six liens are possible for rental property owners, Huettner says.
The waiting time to use a new appraisal, which will take into account repairs and renovations, for an investment property is 12 months from the date of purchase, says Elysia Stobbe, a landlord, mortgage professional and author of How to Get Approved For the Best Mortgage Without Sticking a Fork in Your Eye, a guide to home loans.
Usually two appraisals are required to confirm value, Stobbe says. Otherwise, if it's less than 12 months from the date of purchase, the last recorded sales price will be used, she says.
With all of those potential barriers to taking out equity on rental properties, investors may be best off doing what Hall aims to do with his rentals: have as much equity as he can in them so he can get a line of credit or loan when a major problem pops up on a rental property.
"I want my rental properties to have equity and then I want to have access to that equity," Hall says.