HELOC vs. Traditional Mortgage: Which Is Better for Your Investment Property?

With a traditional mortgage, you borrow a lump sum to buy real estate, often your home. But suppose you want to buy an investment property. Should you explore other options? How, for example, would a HELOC for investment property stack up against a mortgage?

Take the time to learn more about the differences between using a traditional mortgage versus a HELOC when it comes to financing an investment property.

In this article (Skip to...)

• Using a traditional mortgage
• Traditional mortgage qualification
• What is a HELOC?
• Using a HELOC
• HELOC qualification
• HELOCs vs traditional mortgages
• Choosing investment property financing
• Next steps

Using a traditional mortgage for investment property: Pros and cons

Traditional mortgage for investment property pros

The reasons you might want a mortgage to buy investment property are similar to the ones that caused you to choose one for your own home:

1. Mortgage rates tend to be much lower than those for other loans
2. You can choose a fixed rate over up to 30 years, meaning you never have to worry about rates suddenly climbing high
3. It’s a relatively safe, highly regulated borrowing environment with little room for financial predators
4. There are plenty of potential lenders so you can shop around for your best deal
5. You may get federal and state tax breaks on the interest you pay on your mortgage. These differ from those homeowners claim on their domestic mortgages because landlords are businesses. So, consult a trustworthy tax professional

Traditional mortgage for investment property cons

But, of course, there are some downsides, some of which apply only to investment properties:

1. As with your own mortgage on your home, your investment property is at risk if you fall too far behind with payments. Foreclosure could loom
2. Investment property mortgages are seen as riskier than those for your own home. Rates are often slightly higher, typically about 1% (100 basis points). They’re also more challenging to qualify for. This applies to mortgages and HELOCs
3. Closing costs tend to be significantly higher for mortgages than HELOCs. And they could prove a real burden at a time when cash flow is a particular issue for your venture

As always, only you can weigh the pros and cons as they apply to your circumstances.

Traditional mortgage for investment property qualification requirements

You already know that investors perceive a mortgage for investment property as riskier than the one that secures the borrower’s own residence. Is that unfair?

Well, they figure you’ll fight tooth and nail to keep a roof over your head during difficult times. But their experience suggests owners are more philosophical about losing an investment property when things go wrong.

For that reason, you’ll likely have to clear a higher bar to get approved. Expect to need at least a:

1. Credit score in the high 600s or the lower 700s. You may be approved with a 620 score with a 25% down payment
2. Down payment of 15-20% (or higher) of the purchase price
3. Financial cushion — Proven cash reserves to cover a minimum of six months of mortgage payments
4. Debt-to-income ratio of 36% or lower
5. Viable business plan backed up by existing leases or multiple appraisals showing sufficient rental income

In addition to these, you may have to track down willing lenders. Many won’t touch these mortgages because of their perceived riskiness.

What is a HELOC?

A home equity line of credit (HELOC) is a type of second mortgage. It’s secured by real estate, either your home or the investment building. They almost always have variable interest rates, although many lenders let you fix portions of your borrowings — at a price.

How do home equity lines of credit work? In some ways, they are a lot like a credit card. You’re given a credit limit and can borrow, repay and borrow again as often as you like up to that limit. And you pay interest only on your balance. But, unlike a credit card, you can borrow up to 100% of your credit limit without affecting your credit score.

The two phases

There’s another way HELOCs are very different from cards: They have an end date by which you must zero your balance or refinance.

In fact, HELOCs have two phases. During the first (the “draw period”), you can borrow up to your limit and pay only interest on your balance. But then the second phase (the “repayment period”) kicks in. You can’t borrow any more. You must continue paying interest and must zero your balance in equal installments by the agreed date.

You and your lender agree upon how long each phase lasts. Some HELOCs have 10-year draw periods followed by 20-year repayment ones. Those using a home equity line of credit for investment property might often find borrowing even large sums affordable.

Using a HELOC for investment property: Pros and cons

HELOC for investment property pros

So is a home line of credit a good idea? You might prefer a HELOC for investment property to a mortgage for several reasons:

1. You’re backloading your loan costs — During the draw period, you need to pay only interest and don’t have to repay any of the principal (the amount you borrowed). That gives you breathing space to get your investment off the ground when costs are high and revenues may still be building
2. You don’t have to backload your loan costs — You can pay down the principal whenever you want, including during the draw period. So, you can enter the repayment period with a low balance, making each installment small
3. HELOCs typically come with much lower (sometimes zero) closing costs. So you could make significant savings at a critical point for your venture
4. Many lenders allow you to fix the interest rate on tranches of money as you draw these down. However, they often limit the number of times you can do that and might charge you fees and a higher rate for the privilege
5. You might be able to refinance your HELOC before the end of the draw period, thus postponing the repayment period
6. You may get federal and state tax breaks on the interest you pay on your HELOC. These differ from those homeowners claim on their domestic mortgages because landlords are businesses. So, consult a trustworthy tax professional

HELOC for investment property cons

Naturally, there are downsides to any borrowing. And, with a HELOC for investment property, these include:

1. HELOC rates are typically higher than mortgage rates. That’s not always the case but it is overwhelmingly often
2. It can be tougher to get your application approved for a HELOC for investment property than a mortgage for investment property
3. HELOC rates are variable and will float up and down with other interest rates — You may get opportunities to fix the rates on a limited number of draws but that will likely cost you
4. HELOCs are secured on either your home or your investment property. If you fall far behind with payments, your lender could foreclose on whichever secures the loan

Whether you choose a HELOC or a mortgage for your investment property project will depend on your circumstances and plans.

HELOC for investment property qualification requirements

As with a traditional mortgage, you’ll typically need to clear a higher bar to be approved for a HELOC for investment property than an ordinary HELOC. Again, expect to need a:

1. Credit score of 700 or 720 or better
2. Down payment of 20% or higher than the purchase price
3. Financial cushion — Proven cash reserves to cover a minimum of six months of payments
4. Debt-to-income ratio of 40%-50%
5. Viable business plan backed up by existing leases or multiple appraisals showing sufficient rental income

Getting approved for one of these HELOCs may be more challenging than the equivalent mortgage.

HELOCs vs traditional mortgages for real estate investments

You can see the pros and cons of these two borrowing options above. And your choice will likely be determined by the trade-offs between those advantages and disadvantages.

For example, a HELOC’s typically higher interest costs may decisively point you to a mortgage if you make a moderate income from a slow-burn rental business. You’re interested in minimizing your costs over the long term.

Their variable rates might similarly put you off HELOCs. Being a landlord’s tough enough without shouldering the additional risks that arise if and when interest rates skyrocket.

HELOCs are flexible

But you might be swayed by the flexibility of the HELOC if you’re buying a rundown place, making costly improvements, and then anticipate a period of low revenues as you attract new tenants. Paying only interest rather than full mortgage payments during those initial months or years could be the difference between your business thriving or failing.

Similarly, if you’re in the business of flipping homes, a HELOC (secured on your own home) could be used to fund multiple projects over many years. You zero your balance with each sale (with luck) and then use your line of credit to buy and modernize the next home. Rinse and repeat.

Choosing the right financing option for your investment property

You can see the basic trade-off. Do you value more the flexibility and low initial costs of a HELOC? Or do you prefer the predictability and lower overall costs of the mortgage?

How you answer those questions will depend on a range of factors, including your:

1. Funding and anticipated cash flow during the early period of your venture
2. Investment goals — Especially whether you’re in this for a quick return or a long-term investment
3. Personal tolerance for risk and those of any partners

How do those fit within your venture’s needs? That comes next.

Write a business plan

Investing in real estate is nothing if it’s not a business. And you should put a credible business plan in place before you apply for a mortgage or HELOC for investment property.

That should help your lender recognize the value of your venture. But it should also concentrate your mind on three questions:

1. Where is my venture now? (Possibly nowhere beyond an idea. That’s fine)
2. Where do I want it to be in one, five and 30 years?
3. How can I get it there?

The U.S. Small Business Administration has a guide to writing a business plan on its website, including examples. And you can download free or paid-for templates from numerous websites.

Pay particular attention to your cash flow forecasts. These can be highly revealing and may allow you to anticipate issues before they arise. Just make sure your assumptions are realistic.

Find your best investment property lender

Once you have your plan and have decided whether you want a mortgage or HELOC, you’ll need to find some willing lenders. As you know, many lenders don’t offer these products for investment properties.

So, set aside ample time for online research so you can get quotes from multiple lenders. Don’t settle for the first you find. Your business might suffer if you go for a suboptimal loan.

You want the best deal out there. And the time you spend finding it can prove an excellent investment.

HELOC for investment property: Next steps

A traditional mortgage can be better or worse than a HELOC for investment property. It all depends on what you’re looking for in your financing. If you write a business plan for your venture, you’ll have a clearer understanding of your needs. And that may well tell you which type of borrowing will suit you better.

If you are ready to buy an investment property, be sure to explore different financing options and compare rates and terms thoroughly.