Why large Investment Property HELOC's are hard to qualify for and what to do instead

[AJ Wong]

We've seen tremendous interest from investors seeking larger balance investment property HELOC's or home equity lines of credit.

Understandably, investors are looking to tap or access increasing equity positions, many for reinvestment or property portfolio expansion. The challenge with high balance equity lines on investment properties is that the qualifying ratios can be high. 

For example on SFR primary/second home properties, typically HELOC's are structured as a 30 year amortization, with the first 10 years usually being the 'draw' period (time to utilize and pay down the credit line) interest only and 20 years amortized principle and interest payments. Expectedly, lenders will qualify the borrower based on the principal and interest payments of the twenty year amortization at the qualified interest rate (usually prime plus 3-4%). So borrowers need to qualify for the full draw amount with current investment property interest rates of near 12-13%. Although HELOC'S are available on 2-4 unit investment property homes, reduced Max LTV's, rates and amortizations can make $250k+ equity lines even more restrictive.

For example a $400k HELOC or equity line for an investment property at Prime + 4% is a qualifying rate of 12.5%. For investment property HELOC's often the initial draw period is shortened to 5 years and the qualifying payment is shortened to 10 years. In this example the qualifying P&I rate is $5855, usually with conservative DTI (debt to income) ratios of 37-45%. The fully drawn interest only payment would be +/- $4166.

Although the intention of the HELOC is discretionary access to capital, the final purpose is usually for long term reinvestment or portfolio expansion. The most common reasons are down payment funds, renovations and rehab or consolidation and personal expenses.

One alternative for larger and longer term equity liens are DSCR cash out refinances. At favorable LTV's (75% and below) rates can be very competitive (currently in the 7%'s) or sometimes nearly half the rate of interest on alternative second lien positions loans. Many DSCR lenders also offer interest only options and as many are aware qualifying can be very painless. Essentially no income details are required and the loan is based off of the collateral of the property and income, calculated using the active rents, appraisal rent schedule or even STR income or projected income. DSCR are not available for primary or second homes (since they use income to qualify.)

In our same $400k LA example the payment on a cash out DSCR would be nearer $2500+/- (interest only) for the first 10 years and then amortized over twenty years with a payment of $3280ish. Clearly the DSCR is the better loan, but doesn't provide the borrower the option of accessing capital at their discretion. For example if they're only needing to draw $50K (often a minimum required by lenders) the payments on the HELOC might be closer to $700+/- monthly interest only.

In all likelihood borrowers will not be in their HELOC beyond the initial 5-10 year draw period. Generally second liens are refinanced at some point, especially if the proceeds were utilized for a long term project or financing. Here are some tips to maximize the use of leverage without paying for unnecessary interest:

- If the cash out is being utilized for RE acquisition have a strong pre approval and try to align the refinance with the purchase. In other words, have your ducks in a row for the refinance (usually 2-3 weeks for a DSCR cash out refi) and then start shopping. Once you have strong prospects, initiate the refinance application and coordinate the closing as close to the target acquisition as possible. This will close the gap between mortgage payments and rental income.

- With sufficient equity, investors can incorporate other mortgages or debts on other properties into one loan. This can reduce rates, improve cash flow and un-encumber properties for other usages. 

- Borrow more or less than you need. Cash out DSCR's usually allow borrowers to go up to 70-80% of an investment property's appraised value (or equivalent debt service ratios) usually to around $1M loan amount. In the 7%'s that's $70K+ per year in interest. That's not a 'bad' rate to borrower very accessible capital that has to be repaid over a generous 360 installments.

- Most DSCR loans come with standard 3-5 year early payoff penalties. These can usually be reduced or eliminated by absorbing a higher interest rate or buying out in upfront 'points.' Depending on the intention and duration of the borrowed capital investors should be aware of the exact penalty terms and options to reduce costs if a sale of refinance of the property is expected within 2-3-5 years.

For very well qualified borrowers (that can fully verify income) and seeking prime HELOC rates and terms I always suggest checking in with their personal bank or credit union first. Most don't allow alternative income options or investment property lines of credit but they could also offer you a favorable interest rate on a fixed second mortgage.

Many borrowers with very low first mortgage rates are hesitant to refinance or touch their first lien position. It's best to walk through your options with a mortgage professional that can help you make the best financial decision for your near and long term goals.

Anyone take out a healthy HELOC lately? We've had several recent borrowers tap their primary equity for a down payment on a new second home or investment properties.

[German E.]

Hi @AJ Wong, I have an important addition to my comments - as I mentioned I just finished qualifying for a heloc, and I'm in the process of qualifying for a loan on a conforming mortgage for a rental property. As it happens, I have another heloc on $0 balance, and I was curious how heloc payments would be treated for the purposes of DTI. Would they could the maximum payment during the repayment period, which is almost 10 years away?

As it turns out, both the heloc loan officer and the confirming mortgage loan officer said the same thing - since my heloc has a $0 balance, it doesn't count towards DTI calculations! This is at least what they said, and at least in my specific case. Maybe if you're 1 year from starting repayment it would be another story. To be clear, there is no debt counted in my heloc towards DTI, it is treated like a large balance on a credit card that is not being used.

To answer your question, yes, I qualify for these helocs using full income documentation, which is a pain. One thing I discovered recently is they make heavy use of the Schedule E from your tax return, so if you clean up your Schedule E (eg by minimizing repairs and maximizing CapEx and accelerated depreciation), you should be in much better shape.

It would be great to start using DSCR for refinancing properties once the rates get low enough. Question - do you know if ADU income is counted as part of the income for the property? Best,

German