Can I Use a Home Equity Loan to Buy Another House?

Can I Use a Home Equity Loan to Buy Another House?

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Yes, you can use a home equity loan to buy another house. Using a home equity loan (also called a second mortgage) to purchase another home can eliminate or reduce a homeowner’s out-of-pocket expenses. However, taking equity out of your home to buy another house comes with risks. Learn more about using a home equity loan for a second home.

How to get a home equity loan to buy another house

If you’re interested in using home equity to purchase a new home, the value of your house will need to be high enough to support the loan, and you’ll have to meet your lender’s requirements. Here’s how to get a second mortgage to buy another house.

1. Determine the amount you want to borrow. Before taking equity out of your home to buy another house, decide how much you want and need. Home equity loans limit how much you can borrow. In most cases, you can only access up to 85% of the equity in your home. For example, if your home is worth $350,000 and you owe $250,000, you have $100,000 in equity. In this example, the maximum you would be able to borrow is $85,000.

2. Prepare for the application process. Your approval for a home equity loan will depend on multiple factors. The value in your home will determine the maximum amount of equity available, and your financial information will determine how much of that equity you can borrow. In addition, your lender will look at your credit score, income, other outstanding debts and additional information.

3. Shop around for a home equity loan. When taking out a home equity loan for a second home, you can use any lender. The loan does not have to be with your current bank or mortgage company. So the best way to get a competitive interest rate is to shop around and get quotes from multiple lenders. As you compare, look at the interest rate, loan terms, fees and estimated closing costs. You can also negotiate with the lender on the rate or a particular term.

4. Apply to the loan with the best terms. Once you've determined the loan with the best terms, you’re ready to apply. You’ll submit the application and provide the requested information. Your lender will order an appraisal of the home or determine the value using another method.

5. Close on the loan. After you go through the underwriting process, your loan will be ready to close. Before finalizing the loan, make sure you understand the terms carefully. Also, know that the Three-Day Cancellation Rule allows you to cancel a home equity loan without penalty within three days of signing the loan documents.

Pros and cons of using equity to buy another home

Before you use a home equity loan for a second home, consider the pros and cons of taking equity out of your home to buy another house.

Pros

  • You’ll reserve your cash flow. Using home equity to buy a second home keeps cash in your pocket that you would otherwise use for the home purchase. This increased cash flow can result in a healthier emergency fund or go towards other investments.
  • You’ll increase your borrowing power. Buying a house with equity will allow you to make a larger down payment or even cover the entire cost — making you the equivalent of a cash buyer.
  • You’ll borrow at a lower interest rate than with other forms of borrowing. Home equity products typically have lower interest rates than unsecured loans, such as personal loans. Using home equity to purchase a new home will be less expensive than borrowing without putting up collateral.
  • You’ll have better approval chances than with an additional mortgage. Home equity loans are less risky for lenders than mortgages on second homes because a borrower's priority is typically with their primary residence. This may make it easier to get a home equity loan to buy another house than a new separate mortgage.

Cons

  • You’ll put your primary residence at risk. Using a home equity loan to buy a new house can jeopardize your primary home if you’re unable to handle the payments.
  • You’ll have multiple loan payments. Taking equity out of your home to buy another house means you’ll potentially have three loans if you have a mortgage on both your primary residence and the second home in addition to the home equity loan.
  • You’ll pay higher interest rates than on a mortgage. Home equity products have higher interest rates than mortgages, so you’ll be borrowing at a higher total cost.
  • You’ll pay closing costs. When using equity to buy a new home, you’ll have to pay closing costs, which can range from 2% to 5% of the loan amount.

Other options for buying a house with equity

Using a home equity loan to buy another house is just one path borrowers can take. Here are a few additional options for using equity to buy a new home.

Cash-out refinance

A cash-out refinance is one way to buy another property using equity. A cash-out refinance accomplishes two goals. First, it refinances your existing mortgage at market rates, potentially lowering your interest rate. Secondly, it rewrites the loan balance for more than you currently owe, allowing you to walk away with a lump sum to use for the new home purchase. Taking equity out of a home to buy another with a cash-out refinance can be more advantageous than other options because you’ll have a single mortgage instead of two. However, interest rates on cash-out refinances are typically higher than standard refinances, so the actual interest rate will determine if this is a good move.

Home equity line of credit

A home equity line of credit (HELOC) is another option for using home equity to purchase a new home. HELOCs are similar to home equity loans, but instead of receiving the loan proceeds upfront, you have a line of credit that you access during the loan’s "draw period" and repay during the repayment period. This method of using equity to buy investment property can be helpful if you’re "house flipping" because it allows you to purchase the property, pay for renovations and repay the line of credit when the property sells. However, interest rates on HELOCs are typically variable, so there is some instability with this option.

Reverse mortgage

Homeowners 62 or older have an additional option of using equity to buy a second home — a Home Equity Conversion Mortgage (HECM). Commonly known as a reverse mortgage, a HECM allows borrowers to access home equity without making payments. Instead, the loan is repaid when you leave the home. Reverse mortgages provide a flexible way of using equity to buy another home, as borrowers can choose between receiving a lump sum or a line of credit. However, keep in mind that while you won’t make payments with a reverse mortgage, interest will accrue. This causes the loan balance to grow and can result in eating up all of the home’s equity.

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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