Line of credit financing is a flexible way to access cash for real estate investments. It allows you to borrow against the equity in a property, typically through a Home Equity Line of Credit (HELOC), giving you access to funds as needed. Let’s break down how it works.
Eligibility/Requirements
The primary requirement for a line of credit is having sufficient equity in a property. Most lenders will also review your credit score and income. While credit score requirements can vary, a score of at least 620-640 is common. Lenders will also verify your income and may require a debt-to-income ratio under 43% (some may be slightly more or less than this number).
Owner-Occupancy Requirement
For a HELOC, it is more common to see these offered for your primary residence. However, some lenders offer lines of credit for investment properties, but the terms may be less favorable, such as higher interest rates or lower loan-to-value ratios.
Down Payment
Unlike traditional loans, a line of credit doesn’t require a down payment. You’re borrowing against the equity you’ve already built in a property.
Loan-to-Value (LTV) Ratio
The LTV ratio for a line of credit depends on the property type:
- Primary Residence – Lenders may allow you to borrow up to 80-90% of the property’s value, minus any existing mortgage balances.
- Investment Properties – If the line of credit is for an investment property, the LTV ratio is typically lower, usually around 65-75%.
Interest Rates
Lines of credit come with variable interest rates that can fluctuate over time:
- Variable Interest Rates – HELOCs and other lines of credit usually have variable interest rates tied to a market index, such as the prime rate. This means your payments can go up or down depending on interest rate changes.
Amortization Period
Lines of credit have a unique repayment structure. They don’t follow a traditional amortization schedule like most loans.
During the draw period, which typically lasts five to 10 years, you only make interest payments on the amount you’ve borrowed. This allows for lower initial payments and more flexibility.
Once the draw period ends, you enter the repayment period. At this point, your payments will include both interest and principal, ensuring you pay off the borrowed amount over time.
Private Mortgage Insurance (PMI)
There is no PMI requirement with a line of credit since you’re borrowing against equity you’ve already built up in the property.
Loan Limits
Loan limits for lines of credit depend on the lender and the property’s value. The total amount you can borrow is based on the lender’s LTV ratio, minus any existing mortgage debt. For example, if your lender allows you to borrow up to 80% LTV and you owe 50% on your mortgage, you could borrow up to 30% of the property’s value.
Number of Loans Allowed
There are typically no restrictions on the number of lines of credit you can have, but each will depend on the amount of equity available in each property. As long as you have equity and meet lender requirements, you can open multiple lines of credit on different properties.
Seller Concessions
Seller concessions are generally not a factor with lines of credit. Since you’re borrowing against your property’s equity rather than purchasing a new property, concessions do not apply.
Waiting Period After Major Financial Events
Lenders may require a waiting period after major financial events, such as bankruptcy or foreclosure:
- Bankruptcy – After a Chapter 7 bankruptcy, you typically need to wait two to four years to qualify for a line of credit.
- Foreclosure – For a foreclosure, most lenders will require a waiting period of three to seven years before approving a line of credit.
Refinancing Rules
You can refinance a line of credit into a traditional loan or a new HELOC if needed:
- Rate/Term Refinance – You can refinance a line of credit into a traditional fixed-rate loan if you want more predictable payments.
- Cash-Out Refinance – You can refinance a HELOC or line of credit into a new loan that includes both your existing mortgage and the line of credit balance.
- Recast – HELOCs generally do not offer recasting options. Once you enter the repayment phase, you’ll start making both principal and interest payments.
Property Types Eligible
Lines of credit are versatile financing options available for various property types. They are most commonly used for single-family homes, condos and townhomes that are primary residences in the form of Home Equity Lines of Credit (HELOCs).
Some lenders extend these options to investment properties as well.
Special Loan Features
Lines of credit come with a few unique features:
- Draw Period – During the draw period, you can borrow and repay funds as needed. You only pay interest on the amount you borrow.
- Buying In Entities – Most lenders do not allow lines of credit in the name of an entity like an LLC. If you need financing through an LLC, you may need to explore commercial lines of credit or portfolio loans.
- Flexible Access to Funds – A line of credit gives you flexible access to cash, which can be especially useful for real estate investors looking to fund multiple deals, make hard money loans to other investors or capitalize renovations.
Approval and Underwriting Process
The approval process for a line of credit focuses primarily on your equity, credit score, and income. Since you’re borrowing against an existing property, the process is typically quicker and less involved than applying for a new mortgage. However, lenders will still assess your creditworthiness, property value, and ability to repay the loan.
Risks and Considerations
Lines of credit come with several significant risks:
- Variable Interest Rates – Interest rates can fluctuate, potentially leading to higher payments and increased borrowing costs over time, especially in a rising rate environment.
- Equity at Risk – Since you’re using your property as collateral, defaulting on the line of credit could result in foreclosure and the loss of your home or investment property.
- Potential Closure During Economic Crises – During times of financial instability, such as market corrections or global events like the COVID-19 pandemic, lenders may freeze or close lines of credit. This means you shouldn’t rely on them as a guaranteed source of funds in widespread financial emergencies.