Risks of a HELOC on a rental property — MarketWatch
An owner of a fully paid-off rental property who is considering a $50,000 home equity line of credit (HELOC) to replenish cash reserves and pay bills should assess the loan terms and their ability to service the debt if the rate rises. This is stated in a MarketWatch column.
HELOC approval terms
A HELOC is secured by real estate in the same way as a mortgage. If there is no active mortgage on the property, the HELOC lender may obtain a first lien on the property. This is not a problem in itself, but it does not guarantee approval of the application.
The lender's decision will depend on the applicant's credit score, income and assets, rental income from the property, and other loans. To verify rental income, the bank may request a lease agreement and annual tax returns. Some lenders do not offer HELOCs for rental properties, so the applicant may need to compare offers from different institutions.
As noted in the column, a recent Federal Reserve survey on lending standards showed that standards for HELOCs were unchanged, while demand strengthened. At the same time, lending standards for most loan categories remained closer to the tighter end of their historical range.
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Variable rate and property risk
The column's author noted that a HELOC may cost less than carrying credit card debt with a double-digit interest rate. However, a loan secured by real estate creates a risk to that property, especially if the borrowed funds are used to pay off unsecured debt. A HELOC rate is usually variable, so the cost of credit may change over time.
The author also considers it inappropriate to take out a HELOC solely to replenish an emergency fund: in his view, reserve funds should help repay the loan, not the other way around. The final decision depends on the urgency of the need for money, the rates and terms offered, the expected repayment period, and the ability to make payments if the rate rises.
The column also states that the US Federal Reserve announced an interest rate increase of one-quarter of a percentage point, to a range of 3.75–4.0%.
