HELOCs are awesome; it’s kind of like having a credit card with no limit, and HELOCs used with a rental property are even better. Not only are you generating cash flow to cover your expenses and hopefully generate a profit, but you can also borrow against the equity in your home. That being said, if you combine a HELOC on a rental property with other tax and investment strategies, the results can be fantastic. Before considering a HELOC on your rental property, here is what you need to know.
What is a HELOC on a rental property?
A home equity line of credit (HELOC) is a revolving credit line that allows property owners to borrow against the equity in their real estate. Unlike a traditional home equity loan, a HELOC provides ongoing access to funds, much like a credit card, with interest charged only on the amount used.
For real properties, HELOCs can be structured differently. Once a HELOC is approved, the investor enters a draw period (usually 5 to 10 years), during which they can borrow as needed up to the credit limit. After that, the repayment phase begins, and the outstanding balance must be paid off, usually over 10 to 20 years. Because rental properties are riskier for lenders than primary homes, HELOCs tied to them often come with tighter requirements, like a lower loan-to-value ratio (ltv) and higher interest rates.
Best ways to use a HELOC for real estate investing
A HELOC on a rental property can be a game-changer for real estate investors looking to expand their portfolio, improve cash flow, or consolidate debt. Because a HELOC allows revolving access to equity, it offers flexibility that traditional loans don’t provide. That being said, investors need to know what they are doing before taking on a HELOC, as even thought it’s financial power can be awe-inspiring, used incorrectly, it can result in loss and bankruptcy. Below are some of the best ways to use a HELOC for real estate investing.
Purchasing additional rental properties
Funding new property acquisitions is one of the most effective ways to use a HELOC. Rather than waiting to save enough for a down payment or taking on expensive short-term loans, investors can tap into existing equity to finance additional rentals.
Here’s how investors typically use a HELOC in practice: The funds can go toward covering down payments on new investment properties, usually the 20% to 25% required by lenders. Instead of draining personal savings, an investor taps into their HELOC to meet that threshold, then finances the rest of the purchase with a traditional mortgage. In some cases, especially in more affordable markets, a HELOC may even be large enough to cover the full purchase price of a property, letting an investor buy outright without needing a second loan.
Example: Using a HELOC for Purchasing Additional Rental Properties
John owns a rental property valued at $400,000, with a remaining mortgage balance of $200,000. He secures a HELOC with a 75% loan-to-value (LTV) ratio, which allows him to access $100,000 in credit. Rather than taking out another high-interest loan, John uses $50,000 from his HELOC as a down payment for a second rental property, financing the remaining cost with a traditional mortgage. This strategy enables him to expand his real estate portfolio while keeping his cash reserves intact and leveraging existing equity to grow his investments.
Renovating and increasing property value
A HELOC can also be used to finance property upgrades, allowing investors to increase rental income and property value. Unlike a traditional renovation loan, a HELOC gives investors flexibility, they can withdraw funds as needed, avoiding unnecessary interest charges. For example, adding an extra bedroom or converting unused space into livable square footage can significantly increase what a landlord can charge in rent, especially in markets where room count drives pricing. Energy-efficient upgrades like solar panels, better HVAC systems, or added insulation not only reduce monthly operating costs but can also attract tenants looking for lower utility bills and greener living options.
Example: Using a HELOC for Property Renovations
Sarah owns a duplex generating $3,500 per month in rental income. Looking to increase her rental income, she takes out a $75,000 HELOC and invests $50,000 into property upgrades, including kitchen renovations, bathroom remodeling, and smart-home features. As a result, she is able to increase the rent by $400 per unit, boosting her annual rental income by $9,600. On top of that, renovations raise the property’s appraised value by $120,000, improving both cash flow and long-term equity.
Paying off high-interest debt
Many real estate investors take out private loans, hard money loans, or credit card debt to finance property purchases or renovations. These loans often come with high interest rates that can eat into profits and cause both personal and business stress. A HELOC can be used to refinance high-interest debt at a much lower rate, reducing monthly payments and overall financing costs.
Why pay off high-interest debt with a HELOC?
- Lower interest costs: HELOC rates (typically 5-8%) are much lower than credit card rates (18-25%) or hard money loans (10-15%).
- Improved cash flow: Replacing high-interest debt with a HELOC lowers monthly debt obligations, freeing up cash for new investments.
- Simplified repayment: Instead of juggling multiple debt payments, investors can consolidate into one manageable loan structure.
Example: Using a HELOC for Debt Consolidation
Mark has $40,000 in credit card debt with an interest rate of 22%, costing him $880 per month in interest alone. To reduce his financing costs, he secures a HELOC at 6.5% interest and uses it to pay off his credit card balance in full. His new HELOC payment is $271 per month, which means he saves over $600 in monthly interest costs. Instead of wasting money on high-interest payments, Mark can now use the extra cash to reinvest in rental property improvements or expand his portfolio.
Maximizing HELOC Benefits with Cost Segregation
A home equity line of credit (HELOC) can be an effective way to leverage existing equity for real estate investments, but investors should also look for tax strategies that enhance profitability. One powerful way to do this is through cost segregation, which helps accelerate depreciation deductions and reduce taxable income.
1. Accelerating Tax Deductions on Renovations
Many investors use HELOC funds to renovate their properties, but depreciation schedules can affect how quickly those costs can be written off. The IRS typically requires rental property improvements to be depreciated over 27.5 years, but cost segregation allows investors to reclassify certain assets into shorter depreciation categories, such as 5, 7, or 15 years.
Example: Renovation Tax Benefits with Cost Segregation
Sarah takes out a $50,000 HELOC to renovate her rental property. Without cost segregation, she can only deduct a small portion of the cost each year under the 27.5-year depreciation rule. With cost segregation, she can immediately deduct $30,000 of the renovation costs in the first few years, reducing her taxable income and improving cash flow.
| Renovation Cost | Depreciation Without Cost Segregation | Depreciation With Cost Segregation |
|---|---|---|
| $50,000 | Spread over 27.5 years ($1,818 per year) | Accelerated to 5-15 years ($30,000 upfront deduction) |
2. Increasing Cash Flow and Reducing Tax Liability
A HELOC allows investors to purchase additional rental properties, but rental income increases taxable income. Cost segregation can offset this by generating higher depreciation deductions, reducing the investor’s overall tax burden.
Example: Rental Property Acquisition With HELOC and Cost Segregation
Mark purchases a $400,000 rental property using a HELOC-funded down payment. Without cost segregation, his annual depreciation deduction is limited to $14,500 per year. However, by conducting a cost segregation study, he is able to accelerate $90,000 in depreciation deductions within the first five years, significantly lowering his taxable income and increasing his cash flow.
| Property Value | Standard Depreciation (27.5 Years) | Depreciation With Cost Segregation | Total First 5 Years Depreciation |
|---|---|---|---|
| $400,000 | $14,500 per year | $90,000 accelerated deduction | $162,500 total |
3. Combining HELOC Interest Deductions with Cost Segregation
For rental property investors, HELOC interest is tax-deductible when used for property improvements or acquisitions. When combined with cost segregation, investors can achieve two layers of tax benefits—deducting both HELOC interest payments and accelerated depreciation on the same property.
Total tax benefits to be used on a HELOC for a rental
| Tax Strategy | Benefit |
|---|---|
| HELOC Interest Deduction | Reduces taxable income when funds are used for investment purposes |
| Cost Segregation Study | Increases depreciation deductions to offset rental income |
| 1031 Exchange (Optional) | Defers capital gains tax upon property sale |
We spoke to Zach L of Pineapple Money regarding his views on HELOCS: A HELOC gives you flexible access to cash when you need it. You only pay interest on what you borrow, making it cheaper than a typical loan. The rates are usually lower than those of a credit card or a personal loan. When you pay it back, you can borrow again without reapplying.
Pros and cons of using a HELOC on a rental property
Before deciding to use a home equity line of credit (HELOC) for your rental property, it’s essential to weigh the advantages and drawbacks. While a HELOC can provide flexible access to capital and tax benefits, it also comes with lender restrictions and financial risks. The table below outlines the key pros and cons to help real estate investors make an informed decision.
| Pros | Cons |
|---|---|
| Access to flexible capital Borrow as needed without taking a lump sum. |
Strict lender requirements HELOCs on rental properties often require higher credit scores (680+) and lower LTVs (typically 70-80%). |
| Lower interest rates Compared to private loans or hard money lenders. |
Variable interest rates Payments fluctuate, adding risk if interest rates rise. |
| Interest-only payments during the draw period Improves short-term cash flow. |
Risk of foreclosure Defaulting on payments could result in losing the property. |
| Tax-deductible interest If the funds are used for rental property investments. |
Equity reduction Borrowing against your property decreases available equity, limiting future financing options. |
Common risks and how to mitigate them
While a HELOC on a rental property can be a powerful financing tool, it also comes with risks that could impact cash flow, property value, and long-term financial stability. Smart investors take a proactive approach to managing these risks to protect their assets and minimize financial exposure. Below are three major risks associated with using a HELOC and key strategies to mitigate them.
Overleveraging debt
Excessive HELOC borrowing can strain cash flow and limit future financing. Investors should keep borrowing below 50% of available equity, ensure rental income covers payments, and use HELOC funds only for high-ROI investments like acquisitions or renovations.
Interest rate fluctuations
Variable HELOC rates can increase, reducing profitability. To manage this risk, investors can opt for a fixed-rate HELOC, refinance if rates rise, and keep payments below 25% of rental income.
Market downturns
Falling property values and vacancies can impact cash flow. Investors should maintain a 6-12 month cash reserve, diversify rental income sources, and avoid maxing out HELOC limits. Monitoring local market trends helps in adjusting strategies, such as securing long-term leases or refinancing early.
Comparing HELOC interest rates vs. other financing options
To illustrate the cost savings of using a HELOC, here’s a comparison of HELOC rates vs. other common financing options for real estate investors:
| Financing Option | Typical Interest Rate | Best Use Case | Risk Level |
|---|---|---|---|
| HELOC | 5-8% | Renovations, down payments, debt refinancing | Medium – variable rates |
| Cash-Out Refinance | 6-9% | Long-term investments | Medium – higher closing costs |
| Hard Money Loan | 10-15% | Fix-and-flip projects | High – short repayment terms |
| Credit Cards | 18-25% | Short-term emergency financing | High – expensive if not paid quickly |
Final thoughts: HELOCS for rental property are powerful
A HELOC on a rental property can be a valuable financing tool for investors looking to expand their portfolio, renovate for higher cash flow, or refinance expensive debt. Remember, as a rental property is cash flowing like a business, you can get much better tax advantages, such as accelerating depreciation through cost segregation studies.
It does come with risks, including variable interest rates, lender restrictions, and the potential for overleveraging. In fact, HELOCs are not so easy to get, the investor needs to have a good credit history as well as good assets to underwrite the HELO. Careful planning is essential, investors should assess their financial position, compare loan terms, and ensure rental income can support repayments. When used strategically, a HELOC on a rental property can provide the flexibility needed to grow and optimize a real estate investment portfolio.
FAQ
Can I get a HELOC on a rental property with multiple units?
Yes, many lenders offer HELOCs for multi-unit rental properties, but the qualification requirements may be stricter than for single-family rentals. Lenders typically require a lower loan-to-value (LTV) ratio, a higher credit score (often 700+), and strong rental income history to ensure repayment ability. Additionally, some banks may limit HELOC availability to duplexes or fourplexes, while larger multifamily properties often require commercial financing instead.
