You can use a home equity loan to cash out equity that you have built up in a residential property. Some banks allow you to take out equity loans on rental homes. Technically, you can use the cash for any legal purpose, although many property owners only tap equity to finance necessary upgrades and repairs. Rental home loans are harder to obtain than loans on your primary residence. A number of factors including your income and the value of the property can affect your ability to obtain financing.
Equity represents the value of your rental home minus any existing liens, such as a first mortgage. If you default on a loan, your lender can sell the home and use the sale proceeds to pay off your loan debt. If your property has dropped in value, one or both of the lien holders may lose money during the foreclosure sale. On your primary residence, your lenders can obtain mortgage insurance, which protects them in the event of foreclosure-related losses. You typically cannot get mortgage insurance on rental homes. Consequently, most lenders only allow you to tap between 75 percent and 80 percent of your home equity in the form of a mortgage and or an equity loan.
Lenders work on the premise that you are more likely to default on a rental property loan than a loan tied to your primary residence. Risk and interest rates are inextricably linked. Consequently, interest rates on rental property loans are usually higher than on loans tied to your actual residence. Lenders also mitigate risk by offering shorter loan terms on rental properties. While you often can get home equity loans for up to 30 years on primary residences, some lenders cap rental home loans to 10 or 15 year terms.
Higher interest rates and shorter loan terms mean rental home equity loans often result in higher payments than loans secured to primary residences. Lenders determine your ability to repay the loan by calculating your debt-to-income ratio. This involves dividing your monthly credit-related debt into your gross monthly income. DTI caps vary but if the loan amount requested causes your DTI to exceed the acceptable limit then your lender may make a counter offer of a smaller equity loan. You can use properly documented rental income to boost your DTI, so be prepared to provide your lender with rental agreements and tax returns.
In many instances, you can claim federal tax deductions for interest payments on a home equity loan attached to your primary residence. Similarly, you may be able to claim interest paid on a rental home loan as a business expense. However, once you sign the rental home loan agreement you cannot back out of the loan. Home equity loans on primary residences usually have a three day right of rescission. You can nullify the loan by canceling it at any time within three business days -- including Saturdays -- of the loan closing. Loans on rental property have no rescission period.
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