Grow the equity in your second home
According to CoreLogicthe average homeowner earned over $26,000 in home equity in 2020.
If you own a second home or vacation home in a desirable neighborhood, you may have seen even larger than average capital gains.
But what if you want to exploit that equity? Can you take out a home equity loan or HELOC on your second home?
The answer may be yes, but the rules are a bit different than your primary residence. Here’s what to expect.
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Home Equity and HELOC Loans on Vacation Homess
You don’t need to sell your vacation home to access the accumulated equity.
Instead, you can access the value of your home using cash refinance, a home equity loan, or a home equity line of credit (HELOC).
Cashing in on a second home may be more appealing to some homeowners than changing the mortgage on their primary residence or reducing its equity.
Using your secondary residence reduces the risk of having a negative financial situation with your main residence if the market were to deteriorate.
Fortunately, many lenders and banks offer second home mortgages.
It’s a bit trickier if you’re trying to refinance a property that isn’t your primary residence, but that doesn’t mean you can’t benefit from historically low interest rates if you do your homework.
Rules for a HELOC Second Home or Home Equity Loan
Due to the high risk second homes pose to lenders, second home financing usually comes with higher interest rates and stricter financing rules.
Buying a second home involves a higher down payment of 10% or more. And if you’re refinancing a second home you already own, you’ll need sufficient equity to make cashing in worthwhile.
You often have to leave at least 25% of your second home equity intact, which means you’ll need a lot Continued more than 25% equity to make a cash refinance or home equity loan worthwhile.
Additionally, credit score requirements are higher for second homes and debt to income ratio guidelines are stricter.
Additional qualifications may include:
- Own the property for at least one year
- Higher credit scores (often 680-700+)
- Larger down payments, leading to lower loan-to-value (LTV) ratios
- Location restrictions
The good news is that the rules for mortgages on second homes are more lenient than those for investment properties. So it will be easier to find lenders offering home equity loans and HELOCs on your vacation home than on an investment or rental property.
Home equity loan or cash refinance
Fortunately, even though there are stricter requirements, you won’t be stuck with just one loan option to access your second home equity.
Whether it’s a home equity loan, home equity line of credit or cash refinance, you have alternatives.
Whether or not you should refinance in cash or opt for a home equity loan will depend on your specific situation.
Home equity loan or HELOC
If you already have a low fixed rate on your existing loan, a home equity loan is definitely worth looking into. This way, you can keep the rate and payment on your existing mortgage low.
Plus, with a home equity loan or HELOC, you won’t have to start the term of the loan over again and extend the total length of time you pay interest. This can make a second mortgage more attractive for someone who is almost done paying off their existing mortgage balance.
Deciding between a home equity loan or a HELOC can be complex, so you’ll want to do your research. But here are the basics:
- Home Equity Loans involve taking a lump sum out of the equity in your home, which you typically repay over a set repayment period at a fixed interest rate
- Home equity lines of credit involve taking out a revolving line of credit, secured by the equity in your home, that you can borrow and repay as often as you like during a set “draw period.” Once the draw period is over, you will have a set time to pay off the outstanding balance. HELOCs usually have variable rates
Both of these options are second mortgages, which means you take out a new loan above your existing mortgage. You would then have two monthly payments, probably to two different lenders
Refinancing by collection
If you have an above-market rate on your current mortgage, cash-in refinancing could help you remove equity and reduce your interest costs at the same time.
Because a cash-out refinance is a “first” or “main” mortgage, it will generally have a lower interest rate than a home equity loan or line of credit, both of which are second mortgages.
Just note that the rules for a cash refinance on a second home will be stricter than cashing in on a primary residence.
Expect higher interest rates, increased capital requirements and higher minimum credit scores. Also, closing costs are generally higher for a cash refinance than for a second mortgage.
Why are the rules different for second homes?
Before the housing crisis of 2008, homeowners could easily tap into the equity in their homes – and with very little equity.
But after 2010, mortgage lenders began to back away from these loose guidelines.
Instead of lending up to 100% of the equity in your home with relatively low credit requirements, many lenders have stopped offering equity loans of any type on second homes.
Why? Unlike your primary residence, home loans for vacation properties pose a higher risk to lenders.
Your primary residence is considered the least risky when it comes to real estate. The house you live in is probably the only debt that gets paid, no matter how hard times go.
Vacation homes, on the other hand, are riskier. If times get tough, homeowners are more likely to forgo those mortgage payments when the cash is tight.
On top of that, second mortgages — including HELOCs and home equity loans — are already considered riskier. This is because these loans come in the ‘second lien’ position (behind your first mortgage), meaning they could be paid less or not at all in the event of a foreclosure.
So with the double risk factor of a second mortgage on a second home, lenders are understandably more cautious about offering these loans – and they charge higher interest rates when they do.
Don’t forget to shop for interest rates
Buying a vacation home means you can enjoy the financial benefits of owning real estate, as well as a great place to vacation with your family.
Mortgage borrowers will find different lending standards for different types of property, depending on the lender and the mortgage program. If you can’t find a lender who can help, try a local bank or smaller credit union.
Remember to always shop around and compare loan options based on your specific needs and financial goals.
The information contained on The Mortgage Reports website is provided for informational purposes only and does not constitute advertising for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent company or affiliates.