One of the most flexible yet underutilised tools for Australian homeowners is the home equity line of credit (HELOC). Whether you’re looking to take your first steps into property investment or expand your real estate portfolio, understanding how to leverage a HELOC can open doors to new opportunities without the need to liquidate your current assets.
In this blog post, we’ll dive deep into how you can use a HELOC for buying additional investment properties, what benefits it offers, and what steps you can take to secure and manage one effectively in Australia.
Understanding HELOCs
A HELOC is a flexible and revolving line of credit that allows you to borrow against the equity you’ve built up in your property.
HELOCs have a draw period, which refers to the timeframe during which you can access funds, usually up to 10 years. During this period, you can borrow and repay funds as often as you like, up to your credit limit.
After the draw period ends, you enter the repayment period, where you can no longer draw funds and must start paying back both the principal and the interest. This period can last up to 20 years, depending on your specific agreement.
Using HELOCs for Investment Properties
Here are essential pieces of information you need to know about using a HELOC to finance additional property investments, along with its advantages, the steps it involves, and the factors you need to consider.
Using HELOCs for deposit
As stated earlier, a HELOC allows you to use the equity in your existing property as a line of credit. You can use this credit to fund deposits for new property investments without having to sell your current property.
Advantages of Using HELOCs for Property Investments
Below are the benefits you can gain from using HELOCs when investing in additional properties:
- Flexibility: Functioning similarly to a credit card, and unlike traditional loans that provide a lump sum, a HELOC provides you with a credit limit that you can draw from as needed, providing flexibility to manage purchases and cash flow effectively.
- Lower Interest Rates: Typically, HELOCs have lower interest rates compared to other credit products like personal loans, making them a cost-effective option.
- Tax Benefits: Generally, the interest on a HELOC used directly for investment or income-generating purposes is tax-deductible in Australia, providing potential tax advantages.
Step-by-Step Guide to Using HELOCs
Below are the steps on how to use HELOCs when financing additional investment properties in Australia:
1. Assess Your Equity
- Available Equity: Equity is the difference between your property’s market value and the amount you owe. For example, if your home is valued at $1,000,000 and you owe $500,000, your equity is $500,000.
- Usable Equity: Typically, lenders allow you to borrow up to 80% of your home’s value minus any existing loans. In the example above, 80% of $1,000,000 is $800,000, minus the owed $500,000, leaving you $300,000 potentially available to borrow.
2. Check Your Eligibility
- Credit Score: You will likely need a good to excellent credit score. In general, a score above 720 is considered good. Note, however, that in Australia, credit scores can range up to 1200 depending on the credit reporting agency. Also, credit score requirements can vary by lender, and the scale might differ – for example, the maximum could be 1000 or 1200.
- Loan-to-Value (LVR) Ratio: This should not exceed 80% post-borrowing.
- Income: Demonstrate that you have a reliable income, preferably with proof from rental income or employment.
- Debt-to-Income (DTI) Ratio: Keep this under 40-50% to improve your chances of approval.
3. Consider the Costs and Risks
- Interest Rates: HELOCs typically have variable interest rates that could change over time.
- Fees: Be aware of application fees, ongoing account fees, and potential valuation fees.
- Risks: Using your home as collateral means you risk losing it if you can’t meet the loan repayments.
4. Shop Around for Lenders
- Research various lenders to compare interest rates, fees, and the terms of the HELOC. Not all lenders offer HELOCs on investment properties due to their higher risk nature.
5. Apply for the HELOC
- Once you’ve chosen a lender, submit your application. You’ll need to provide details, such as income, property valuation, home equity, and personal identification. The lender will assess these alongside your credit score to determine your eligibility.
- Complete any lender-specific requirements, which might include a detailed proposal of how you intend to use the funds.
6. Use the Funds Wisely
- Once approved, draw from the HELOC as needed for your investment property.
- Aside from using the funds as a deposit for buying an investment property, you can also use them for capital improvements that increase the property’s value.
7. Manage Your Loan
- Make interest-only payments during the draw period as required.
- Be strategic about repayment by focusing on paying down the principal to reduce interest costs over time and avoid potential financial strain.
8. Monitor and Adjust
- Keep an eye on property and market values, as a decrease could affect your equity and LVR.
- Adjust your financial strategy as necessary based on changes in interest rates and your financial situation.
Key Considerations
While a HELOC offers significant advantages, there are key factors to keep in mind when using it:
- Risk Management: Remember that using a HELOC to invest in property secures the loan against your home. If investments fail or you cannot meet the repayment terms, you risk losing your primary residence.
- Debt Management: Use the funds from your HELOC wisely. Ensure that the potential income from the investment property can cover your new debt obligations and that you maintain an adequate buffer for unforeseen expenses.
- Interest Fluctuations: HELOCs typically have variable interest rates. If rates rise, so do your repayments, which could affect your budget and financial stability.
- Market Value Risks: Property values can fluctuate. If your investment property or primary residence decreases in value, you might end up owing more than the worth of your properties, known as negative equity.
- Financial Discipline: The flexibility of a HELOC requires strict financial discipline. Without careful management, you could overextend yourself financially.
Final Thoughts
Using a HELOC to finance additional property investments offers flexibility and cost-effectiveness for homeowners. However, the flexibility it offers can be a double-edged sword, requiring discipline and careful financial planning to manage effectively.
As with any financial product, it’s essential to understand how it fits into your overall financial strategy and whether it aligns with your long-term goals. If you’re considering a HELOC, we recommend consulting with a financial advisor to fully understand its implications and tailor this strategy to your personal financial situation.
