Can You Use A Home Equity Loan To Buy Another House?

It’s possible to use a home equity loan to buy another house. If you have a good chunk of home equity, you can tap into it to buy a second home or an investment property.

Before you do so, you’ll want to weigh all your options and the risks of making such a move. Financing another large purchase can come with significant risks, especially since you’re also putting another lien on your primary home. To help you in the decision-making process, we’ll break down what a home equity loan is, whether you can use one to buy another house and other financing choices to consider.

What Is A Home Equity Loan And How Does It Work?

A home equity loan is a type of installment loan that allows you to use your home equity for a lump sum loan then pay it back in monthly payments. Home equity is the portion of your home that you truly own. It’s based on the current market value of your home and how much you still owe on your mortgage. For example, if your home is valued at $650,000 and you still owe $350,000 on your mortgage, then you have $300,000 worth of home equity.

While it’s typically a fixed-rate loan (the interest rate and monthly payments don’t change), there are variable-rate loans (rates fluctuate based on economic conditions) as well. A home equity loan is technically a second mortgage or lien on our home. Your home serves as collateral for your loan in case you default. Once you take out the loan, you will make payments at the agreed-upon term and interest rate.

Most lenders don’t let you borrow the entirety of your home’s equity. Rather, you can qualify up to a certain percentage — typically 80% to 90%. So if you have $300,000 worth of home equity, you may be able to borrow $240,000 to $270,000.

Other factors lenders consider is your credit profile, debt-to-income ratio (DTI) and how much you earn.

Pros And Cons Of Using A Home Equity Loan To Buy Another House

Using a home equity loan to buy another house may be a smart financial move, but it does come with disadvantages. Factors to take into account include the following:

Pros

●      Potentially lower interest rates: Home equity loans typically come with lower interest rates compared to other options like personal loans and credit cards. If you need to pay closing costs, those could be lower compared to other loans, too.

●      Housing costs can go down: By using your home equity to help pay for another home, you may end up borrowing less for the mortgage on your second home or investment property.

●      No need to tap into savings: Buying another home means you may have to put up a lot of upfront cash. By using a home equity loan, you may be able to buy a new property sooner without having to save up more cash.

Cons

●      The primary home is collateral: A home equity loan means your home is used as collateral. If you default, you could lose your home. Same goes for your second home if you can’t afford the payments.

●      Additional loan payments: Financing two homes can come with additional financial burdens in the form of two loan payments. It’s important to make sure you can afford these payments as well as other housing-related costs before buying an additional home.

●      Higher costs: Home equity loans usually come with closing costs and other fees. While at times they may be lower than other loan types, it’s an additional cost nonetheless.

Using A Home Equity Loan For A Second Home Vs. An Investment Property

Using a home equity loan for a second home or an investment property usually has the same requirements, though your lender will let you know exactly what you need. As with a mortgage for a primary residence, you’ll need to provide certain documentation, such as:

●      Your contact information

●      Social Security number

●      Tax documentation (like tax returns and W2 forms)

●      Pay stubs

●      Bank statements

●      Brokerage account statements or documentation of assets

Since you’re taking out an additional loan on your home, lenders may want you to have a higher credit score.

In many cases, lenders will ask that you have a higher down payment for loans for a second home or investment property. Depending on how much you can take out for a home equity loan, you may need to use up a good chunk of it on the down payment.

Alternative Options To A Home Equity Loan To Buy Real Estate

A home equity loan to purchase a second home or investment property may not be the best choice for your needs. Instead, you can consider alternatives such as a cash-out refinance or personal loan to fund your next purchase.

Home Equity Line Of Credit (HELOC)

A HELOC is a type of home equity loan, but you don't have to access all the loan proceeds in one lump sum. Instead, you're approved up to a certain loan amount and draw it from a credit line as needed. It's revolving credit, so if you pay back the loan during the draw period, you can draw from it again. HELOCs typically allow you to draw from the loan for a certain amount of time, and then you'll have a repayment period. The risks for a HELOC are similar to a home equity loan.

Cash-Out Refinance

A cash-out refinance is a process by which you take out a new mortgage, pay off your existing one and use the remaining loan amount for anything you wish (like paying for another). Instead of two loans, you have one larger loan, which could simplify payments. You may still pay closing costs and other related fees.

Reverse Mortgage

A reverse mortgage can be an option for those who are at least 62 years old and wish to convert home equity into cash. The lender will pay you monthly payments and you can use it toward purchasing another home. You must live in the first home as a primary residence. While you won't have to make any mortgage payments as long as you agree to the reverse mortgage terms, you will need to pay to maintain your home and stay current on property taxes and homeowners insurance. When you pass away, move, or you can’t adhere to the lender’s terms, your reverse mortgage comes due. Either you or your heirs will need to either buy the home, sell it or forfeit the property to the lender. Reverse mortgages are complicated and expensive loans. It’s recommended you speak to a financial advisor to determine if this loan option is right for you.

Personal Loan

A personal loan is an installment loan that provides a lump sum payment you may use to help finance your second property. While interest rates may be higher, the loan isn’t tied to your home. Some lenders may have restrictions as to how you can use a personal loan to buy a second property, so it’s best to check before submitting an application.

Retirement Savings

Using retirement savings like your 401(k) or individual retirement accounts (IRAs) is a possibility. However, you may have to pay taxes and penalties on your withdrawals if you don’t meet certain requirements. What’s more, taking out money from these accounts could mean losing potential future earnings, which could affect your retirement goals. Speak to a financial professional to see if this option is a good idea based on your situation.

Using A Home Equity Loan For A Second Home: FAQs

Still not sure if using a home equity for a second home is for you? Consider these frequently asked questions.

How much equity can I borrow from my home?

In most cases lenders will only allow homeowners to borrow up to 90% of your home equity. The final amount will also depend on other factors such as your credit profile and your home’s appraised value.

Is a home equity loan better than a HELOC?

Both home equity loans and HELOCs allow you to tap into your home’s equity. A HELOC is generally better suited for homeowners who aren’t sure how much money they’ll need or want to borrow. That’s because a HELOC allows them to tap into a revolving loan over a period of time for different financing needs. A home equity loan is typically better suited for those who want a lump sum of cash and know exactly how much they need to borrow.

Can you use a home equity loan to make a down payment?

Yes, in most cases you can use a home equity loan to make a down payment on another home. Ask your mortgage lender if it’s possible to do so.

Bottom Line

A home equity loan is a second mortgage that allows you to borrow from your home equity. The funds can be used for almost any purpose, including purchasing a second home or investment property. However, taking out this type of loan can come with financial risks, such as the potential to lose your home if you default.

As you’re exploring your options consider starting the initial approval process to finance a second home or investment property with a home equity loan. That way you can see what you may qualify for and then make an informed decision.