If you’re looking for the “too long; didn’t read” answer, it’s yes. You can leverage the equity in your current home to purchase a second property.
Like many of the issues and questions around property loans, however, your individual financial circumstances and goals—plus current real estate market trends—are key to determining if a home equity loan is the best choice for you.
Below we’ll take a look at the what, the why, and even, the why not of using a home equity loan to buy another house.
What is a Home Equity Loan?
A home equity loan is a way of taking cash out of your primary residence without selling your house. Your home equity is based on the current market value of your home minus how much you still owe on your existing mortgage.
Home equity loans typically limit the amount to 80% – 90% of your usable equity.1 For example, if Macy’s home is currently worth $250,000, and she still owes $150,000 on her home loan, then a traditional lender may allow her to borrow up to $85,000 (85% of her $100,000 equity).
The interest rate on a home equity loan is:
- Fixed rather than a variable interest rate
- Dependent on your credit history and debt-to-income ratio
- Tied to the length of the loan term, which is typically five to 15 years
Pros and Cons of Using Home Equity to Buy Another House
A second home can be a key part of meeting personal and family goals. Maybe you intend to have a cabin by the lake to keep your blood pressure down through early morning fishing. Perhaps your second home is a pathway to rental income, or a way to step into your dream house while allowing family members to remain in the current home.
Considering the many different scenarios, when is a home equity loan the best choice to reach those goals?
Advantages of Using Home Equity for a Second Home Purchase
Paying down your mortgage home loan over time while your property value increases means you may have grown a valuable asset. The plus sides of tapping into it with a home equity loan include:
- Purchasing now instead of waiting to save up enough money
- Lower interest rate with a secured loan vs unsecured loan or credit card
- Avoid tapping into retirement, emergency savings, or other key funds
Plus, you’ll have a larger down payment, which can provide:
- A lower interest rate
- No private mortgage insurance (PMI) on your new mortgage
- Lower monthly mortgage payments
Risks Involved in Using Home Equity for a Second Home Purchase
Instead of “can I use a home equity loan to buy another house,” ask yourself “should I use a home equity loan to buy another house.”
The downsides to leveraging your equity include:
- Foreclosure – The biggest risk of a property-secured loan is the possibility of losing it through foreclosure if you can’t make your monthly payments.
- Multiple payments – Instead of one payment (your current mortgage), a home equity loan as a bridge to a second property means you’ll likely need to budget for three monthly payments: current mortgage, home equity loan, and the second home mortgage.
- Closing costs – In addition to paying closing costs on your new home or investment property purchase, you’ll also have to pay them on the home equity loan (usually 2% – 5% of the total loan amount).2
Alternatives to Home Equity Loans for Buying a Second House
If you’ve been denied a home equity loan, or you’re considering getting a home equity loan with bad credit, there are alternatives available. A home equity loan isn’t the only option to fund a second house. You can also convert equity to cash through a:
- Cash-out refinance
- Home equity line of credit (HELOC)
- Reverse mortgage
- Sale-leaseback program
How Sale-Leaseback Programs Can Be an Alternative to Home Equity Loans
Of the alternatives listed above, only one is not a type of loan.
There are many sale-leaseback benefits to consider. A sale-leaseback is a unique way to convert your equity to cash and continue living in your home without taking on more debt. It combines the sale of your home to an investor-landlord with a unique contract that:
- Guarantees your right to remain in your home as a renter
- Locks in an agreed-upon rental rate
- Spells out limits on future rate increases
In addition to paying off your current mortgage and receiving cash upon the sale, you can reduce your monthly housing costs. Instead of adding multiple mortgage and loan payments, you’ll be ditching these costs for your current home:
- Property tax
- Homeowners insurance
- Covered repairs and maintenance
You can leverage your home equity in a variety of ways to fund the purchase of a second home.
If you opt for a traditional home equity loan, be sure to analyze your ability to make payments on your current mortgage, new home equity loan, and new home mortgage. A home equity loan offers a lower interest rate than unsecured debt, but it includes the risk of foreclosure if you cannot make your monthly payments.
A sale-leaseback, or rent-back agreement, is another option that allows you to leverage your home equity to fund a second home purchase. Unlike a home equity loan, you may be able to reduce your debt load and monthly housing costs rather than increasing them.
- Investopedia. How a Home Equity Loan Works, Rates, Requirements & Calculator. https://www.investopedia.com/terms/h/homeequityloan.asp
- Investopedia. Can I Use a Home Equity Loan To Buy Another House? https://www.investopedia.com/can-i-use-a-home-equity-loan-to-buy-another-house-5200330