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My Mortgage Blog

Getting approved for a mortgage loan can be a long and daunting part of buying real estate. If you have successfully navigated that process to buy the home you live in, you may want a more simplified option in the future.

The process for financing a rental property is different than for owner-occupied homes. Among other requirements, the down payment for the loan is a minimum of 20% of the purchase price. As Leenan Homes explains, that is because a rental property is not seen as a necessity like your residential home. As a result, investment property loans carry stiffer terms. 

 

Moreover, investment properties pose a greater risk to lenders. Statistics show that people are more likely to default on mortgage payments for a rental than payments for their own homes. This is because they don’t live in the rental themselves and losing the property will not make them homeless. That is why lenders expect more when you want to borrow for a rental property; they are insulating themselves against the added risk.

 

Fortunately, you can avoid all that hassle if you have lived in your own home for a considerable length of time.


Leveraging your home equity to buy a rental property

When you take a loan to buy a house, you take possession of the property but the home does not belong to you. Ownership of the property is split between you and the lender, based on how much you put down to buy the property.


If you paid 5% of the purchase price out of pocket, your ownership is limited to that 5%. The bank owns the remaining 95%. This 5% is your equity in the home. But your equity in the property is not static; it grows as you make the monthly mortgage payments for the home.


These monthly payments are the means to transfer ownership from the lender to yourself. If you diligently make those payments over the years, your equity in the home will become significant. Home equity also grows through value appreciation and improvements you make to the house.

 

If substantial enough, your home equity can serve as the basis for buying a rental property. Lenders will allow you to take money out of your accumulated home equity and spend it on anything you want, including making the down payment on a rental property.

 

How does this process work?


How to finance a rental property using your home equity

These are the steps to follow if you want to leverage your home equity to buy a rental property:

  1. Know the current market value of your home

    It may be difficult to get an exact value for the home, but you can estimate it. To do this, check Zillow and Redfin for the average prices of properties in your area. The homes you use as a benchmark should be similar to your home. The two sites will provide different estimates; use the average of the two figures. As your Mortgage Broker, I cover the cost of appraisals for my clients in cases like this. 

  2. Determine how much you owe on your home 

    Your mortgage balance will tell you what you still owe on the property. To know your balance, look at your last mortgage statement or log into the lender’s website to get the information. If you have taken other loans for the home – home improvement loan, for instance – include this when calculating the mortgage balance.

  3. Calculate to know your home equity 

    Deduct your mortgage balance from the estimated value of the home. The resulting amount is a rough estimate of your home equity. From there, I calculate how much of that equity you will be able to access. Most lenders are willing to finance up to 80% loan-to-value (LTV) on your home. For example, if your home is valued at $400,000 and your mortgage balance is currently $200,000, this means you have 50% equity in your home. Taking the loan back up to 80% LTV means you could finance it back up to $320,000. After paying out your existing mortgage balance of $200,000, you are left with $120,000-ish to do with as you please – possibly put down 20% on a rental property purchase. Keep in mind there will be a penalty for paying out your existing mortgage if you change lenders – always speak to your Mortgage Professional about the costs and benefits of your mortgage plans.


Home equity borrowing options

Once you have determined how much you can borrow and found a rental property you want to buy, the next step is to find a lender who will loan you the money. That’s where I come in! I have connections to a variety of lenders, all with their own solutions for your mortgage needs. It is my job to help you sort through the offers and available products you qualify for to see what your best option is. There are two types of financing that will grant you access to the equity in your home: home equity loans or HELOCs.


Home equity loans

Home equity loans place a lump sum at your disposal on which you will pay a fixed amount every month. The interest rate for this type of loan is fixed, and you have to pay the closing costs (typically, 2% - 5%). This kind of loan is preferable for buying a rental property that you intend to rent to tenants, also known as buy and hold real estate investing.

Home equity lines of credit

A home equity line of credit (HELOC) is a line of credit that, like a credit card, provides credit on a revolving basis. Unlike a credit card, a HELOC is secured to your home. You will only incur charges for the money you draw from the account. You can make use of this money and repay it as often as you want during the loan term. HELOCs use a variable interest rate which is charged on the drawn amount only. This type of loan is advisable for shorter term investing goals, such as buying a rental property you intend to flip.


Regardless of what your next real estate goals may be, I’m always here to guide you through the financing side. Fill out an online application to start the conversation!