Whether you dream of a place that can become your retirement home or a place for family vacations, there are cost-efficient ways to make your fantasy a reality.
For example, some homeowners hedge the bets on their lottery tickets with financing solutions like HELOCs (aka home equity lines of credit).
Is a HELOC the right option for you? To understand, we’ve assembled this guide to using HELOC to buy a vacation home.
Step 1: Understanding the Terms of a HELOC
If you’re new to the idea of HELOCs and using a HELOC to buy a vacation home, let’s break it down. A home equity line of credit (HELOC) “taps into your home equity value and functions on similar principles as a credit card does,” but with a lower interest rate. It isn’t a home equity loan alternative because the lender doesn’t give a lump sum but instead uses the equity for a line of credit. The only similarity is that a home equity loan and HELOC use the home as collateral.
How does it work?
- Homeowners acquire equity when the value of their home increases over time. The actual quantity of your home equity is the total value of the home minus any outstanding loans (i.e., mortgage loans, home equity loans, etc.) If you want a clearer idea, hire an appraiser to determine the appraised value.
- If you have more than 20% home equity, you’ll be able to qualify for a HELOC. Your bank will give you a credit limit (generally a bit less than your equity), and you’ll be able to use your HELOC credit to make purchases, pay off debt, or remodel your home. Just as with a credit card, you’ll only owe the balance you actually spend (plus interest).
- When using a HELOC, homeowners can have quick access to the equity acquired without selling and moving from their home.
Overall, using a HELOC gives you convenient access to your home’s value.
However, keep in mind that it is still a loan, and you’ll be responsible for paying it off.
Step 2: Run the Numbers
Now that you know how to acquire funds from a HELOC, it is clearer how people can finance such luxuries as a vacation home or investing in real estate. By freeing up money, these funds can be placed toward your new home-away-from-home.
However, keep in mind that your HELOC may not finance your entire vacation home or future primary residence.
- If you only have $20,000 in home equity, you’ll be unable to buy a vacation home outright in most domestic and international locales.
- Without sufficient funds from your HELOC, you may need to take out a mortgage loan to cover the remaining balance on your vacation property. That means you’ll start with little equity in your vacation home—instead, you’ll be adding significantly to your debt.
Let’s look at a simple example: You purchased your home years ago for $180,000, and at the present day, your home is worth $250,000. This means your home’s equity is $80,000. Now, you have your heart set on a cute, little vacation home in Florida.
- You qualify for a $65,000 HELOC – Your HELOC “credit card” balance starts now at $0. You then use $50,000 as a down payment for your vacation home. This borrowed $50,000 will be paid back in the future.
- You now have two mortgages – You now have two properties. This means you are paying the mortgage for your home and on your vacation home. These fees are paid monthly as normal. Should you have money to spare, you can start paying back the HELOC at any time.
- HELOC Repayment begins in 10 years – After your HELOC term has ended, you are now given a time frame, typically 20 years, to repay what you’ve borrowed. With minimal interest accrued, you can treat this like a credit card statement and pay back the monthly minimum or pay it off earlier.
Take a careful look at your current assets and outstanding debts to understand how purchasing a home with a HELOC will affect your long-term financial health. Keep in mind that vacation homes still require property taxes in most states, learn more about Florida property tax rates before you buy.
Step 3: Weigh the Pros and Cons of HELOC for Vacation Homes
But before you start the application process, consider whether it’s truly prudent to take on more debt to finance your vacation home.
Consider the following:
- How will owning two properties affect your finances?
- How much of your home’s equity will you need?
- Do you plan on renting out the vacation home? If so, how much will you make?
Then, weigh the pros and cons of using a HELOC.
The benefits of using a HELOC for your vacation home are:
- Building equity for your home and vacation home – Purchasing a vacation home using a HELOC allows homeowners to leverage against their own equity to expand their equity further.
- Low interest rate – Compared to credit cards and loans, a HELOC has a lower interest rate. This is useful since a house is an ongoing investment.
- Low monthly payment for the first 10 years – By using a HELOC for the down payment, the homeowner can ensure that their monthly mortgage is low and affordable..
However, there are some potential downsides.
- You’ll add to your debt – In the long term, you’ll develop equity in both of your properties—assuming the housing market in your geographic market stays strong, and you’re able to keep up with payments. But in the short term, you’ll have significantly more outstanding debt. Beyond adding stress, extra debt can affect your credit score and ability to qualify for other loans (i.e., student loans, auto loans).
- Income loss could leave you underwater – Even if you’re able to afford your existing mortgage payments now, job loss, retirement, or other changes to your monthly income could make it difficult to keep up with loan payments on two properties plus a HELOC loan.
- Variable interest rate – Because the interest is subject to change, there’s no telling when it will become a higher interest rate or lower interest rate. There’s a chance your monthly payment increases throughout the repayment period.
But don’t fret—there are other alternatives.
HELOC Alternatives for Buying a Vacation Home
A sale-leaseback program is different from a lender or HELOC. It may help you sell, move, stay, release, and can convert your equity to cash.
If you’re looking to take the next steps into buying a vacation home, a sale-leaseback solution is a home equity loan alternative that may serve homeowners in all financial standings. Sale-leaseback solutions are tailored to help homeowners invest in themselves.
If you are also seeking a HELOC with bad credit, a HECM might be a better option for you.
Is a HELOC to buy a vacation home the right option for you? The HELOC taps into your home equity value and allows you to obtain the equity found in your home. If you are still unsure of alternative options for cost-efficient financing through HELOC, after reading this article, consult a financial advisor to discuss your options.
- Bankrate. The pros and cons of a home equity line of credit (HELOC). https://www.bankrate.com/home-equity/pros-cons-of-home-equity-lines/
- Investopedia. Is Taking out a HELOC Right for You? https://www.investopedia.com/financial-edge/0911/is-taking-out-a-heloc-right-for-you.aspx