If you have significant equity in your primary residence, you can tap into it with a home equity loan. You can then use that money for whatever purpose you want, including buying a second home or an investment property. Using a home loan to buy another home is not without risk, however, so it’s a good idea to understand the pros and cons before proceeding.
Key points to remember
- If you have enough equity in your home, you can use the money from a home equity loan to buy another home.
- Like regular mortgages, home equity loans are secured by your home, so you’ll be putting it at risk if you’re unable to repay the loan.
- There are other ways to borrow that may be better in some cases.
Click play to learn how to use a home equity loan to buy another home
Using a home equity loan to buy another home
The short answer to whether you can use a home loan to buy another home is yes, you usually can. Keep in mind, however, that some lenders may have restrictions on the source of your down payment and may not be willing to issue a mortgage on the new home if you are using a home equity loan for this purpose. Of course, that won’t be a problem if you pay everything in cash for the new house.
Unlike a home equity line of credit (HELOC), which provides a revolving line of credit, a home equity loan gives you the full loan amount up front. The amount will depend on the equity in your home, its market value and how much you want to borrow. Your income and credit history will also affect the loan amount. Most lenders will cap the total amount at a percentage (usually 85%) of the home’s value. When your home equity loan closes, you’ll receive the entire proceeds and can then spend the money to buy another home or do whatever you want with it.
Advantages and Disadvantages of Using a Home Equity Loan to Buy Another Home
The main advantage of using a home loan to buy a second home is that it can be your best (or only) major source of financing if you find yourself home rich but cash poor. Another potential benefit is that interest rates on home equity loans will often be lower than other forms of borrowing, although they are generally higher than interest rates on a mortgage.
The biggest downside to using a home equity loan to buy another property – or for any other purpose – is that you put your primary residence at risk because it serves as collateral to secure the loan. If you find yourself unable to make payments on your home loan, the lender could foreclose on your home and evict you.
An added danger is that by taking out a home equity loan, especially if you still owe money on your first mortgage, you could find yourself overwhelmed with debt if you face an unexpected financial reversal, such as a loss of money. job or big medical bills. Indeed, you could find yourself having to pay off three mortgages at once: the rest of the mortgage on your principal residence, a mortgage on your second house (if your loan is not large enough to buy the house directly), and your home equity loan.
Finally, another disadvantage is that you will have to pay home equity loan closing costs, which could be between 2% and 5% of the total cost of the loan. You will also have to pay the closing costs of the house you are buying.
Alternatives to Using a Home Loan to Buy Another Home
Before applying for a home equity loan to buy another home, it is worth considering the alternatives. They too have advantages and disadvantages.
The best source of money to buy another house would be money that you have already saved up and have no other immediate need for. Of course, if you have this, you shouldn’t apply for a loan at all.
Your retirement savings are a possibility. If you have a 401(k) plan at work, for example, your employer may allow you to borrow some of it through a 401(k) loan. Like home equity loans, pension plan loans can be risky. You will usually have to repay the loan within five years, or even sooner if you lose your job. If you cannot repay it, you will have to pay income taxes and possible penalties.
If you borrow from your 401(k), you’ll have a lot less money saved for your retirement years, which could mean financial trouble down the road.
You might consider a personal loan. You’ll pay a higher interest rate than with a home equity loan or HELOC, but if the personal loan is unsecured, your home won’t be at risk if you fall behind on your payments.
Refinancing by collection
A cash refinance pays off your current mortgage with more based on the accumulated equity in your home. You can then use the extra money for other purposes. Of course, you will now have more debt and higher monthly mortgage payments. These loans also have closing costs of up to thousands of dollars.
Home Equity Line of Credit (HELOC)
Using a HELOC to buy an investment property, rental property, or second home can give you more flexibility than with a home equity loan, in that you don’t have to take all the money at the same time. This can be useful if you need money now for a down payment and expect to need more money in a year or two for renovations. However, HELOCs typically carry variable interest rates, making them less predictable than a home equity loan, which typically has a fixed rate.
If you’re 62 or older and want to become a homeowner in retirement, you can take out a federally insured home equity conversion mortgage (HECM), better known as a reverse mortgage, to purchase property. rental in order to provide you with a stream of income. in your twilight years.
A HECM converts the equity in your home into cash which is generally tax-free and does not affect your Social Security and Medicare. The lender pays you the money and you have no monthly payment on the mortgage. Indeed, as long as you live in the house, you do not have to pay off the mortgage at all, although you still have to pay the maintenance costs of your house. However, when you leave the house, sell the house, or die, you, your spouse, or your estate must pay off the entire mortgage, plus interest at a variable rate that accrues over the life of the loan and eats away home equity.
This means that if you plan to leave your home to your heirs, the bill will be high to be able to do so. Yet, at that point, the proceeds from the sale of your rental property could potentially pay off the reverse mortgage.
Can you use a home equity loan to make a down payment on a house?
Yes, if you have enough equity in your current home, you can use the money from an equity loan to make a down payment on another home or even buy another home without a mortgage. Note that not all lenders allow this, so if you plan to buy the second home with a mortgage, you may need to shop around to find one that does.
How much money can you get from a home equity loan?
Generally, you can borrow up to 85% of the equity in your home. However, you may have to pay several thousand dollars in closing costs, so you’re not giving up the deal with the full 85%.
What are the risks of using a home equity loan to buy another home?
The main risk with a mortgage, like a regular mortgage, is that it is secured by your home. This means that if you are unable to meet the payments, your lender could foreclose on the house, sell it and evict you. Instead of a home equity loan, you may also qualify for an unsecured personal loan, which won’t put your home at risk, although it usually has a higher interest rate.
Which is better: a home equity loan or a home equity line of credit (HELOC)?
It depends on what you need the money for. A home equity loan may be preferable if you need a lump sum of money at some point, for example to buy another house. A home equity line of credit (HELOC) might be better if you don’t need all the money at once, but expect to spend it in stages. Some lines of credit remain open for up to 10 years.
From an interest rate perspective, a home equity loan may be safer because its interest rate is fixed, while a HELOC’s rate is variable. Borrowers with HELOCs have some protection in the form of caps on how quickly their interest rates can rise, although this may vary from lender to lender.