Can I Use A Home Equity Loan To Buy Another House?

Can you use a home equity loan to buy another house? The short answer is yes. However, the advantages and disadvantages of this strategy may depend on how you use the second property. A home equity loan can also be a good option for buyers interested in purchasing an investment property.

We’ll delve into the process of using a home equity loan to buy a second property and explore the benefits and drawbacks of this financing option.

What Is A Home Equity Loan?

To understand how to use home equity toward your next property purchase, you must understand how a home equity loan works. A home equity loan is a type of second mortgage that allows you to access the equity you’ve built in your home.

Home equity is the difference between your home’s value and what you owe your lender on your mortgage. You build equity as you make mortgage payments and reduce your loan balance. With a home equity loan, you receive a lump-sum payment of some of your equity, which you pay back to a lender in fixed installments over the loan’s term.

Advantages Of Using Home Equity To Buy An Investment Property

A home equity loan can offer two key advantages: increased liquidity and the potential to make a second property purchase less expensive. Using home equity to buy an investment property offers a few distinct advantages.

• You can increase your down payment. You receive the funds from a home equity loan as a lump-sum payment. Using the funds as a down payment on an investment property may lower your monthly payment and loan interest rate.
• You can solve financing challenges. Second properties are typically more difficult to finance due to the stricter credit and down payment requirements of traditional mortgage loans. A home equity loan can be a convenient, affordable solution for buyers interested in investment properties.
• Your interest rate will likely be lower. You can avoid high interest rates with a home equity loan because they’re secured by real estate collateral. Lenders may also offer lower fees and closing costs.

Disadvantages Of Using Home Equity To Buy An Investment Property

Despite the benefits of using home equity to buy an investment property, there are some potential risks.

• You’re trading an asset for debt. When you take out a home equity loan, you’re essentially turning an asset (your home) into debt by linking the portion of the home you own to another loan.
• You’re vulnerable to shifts in the housing market. Reduced market values can decrease the equity you have in your home, which may result in a loss of profits when you resell the investment property.
• You could have three mortgages for two homes. A home equity loan is a second mortgage on a primary residence. With a separate mortgage to finance your second home, you’ll likely have three mortgages for two properties.
• Your interest payments may not be tax deductible. We recommend consulting with an accountant before making any decisions. Changes to the tax code due to the Tax Cuts and Jobs Act of 2018 may impact the deductibility of interest payments for home equity loans.

Alternative Methods To Using Home Equity To Buy A Second Home

A home equity loan is one way to purchase a second home – but there are other financing strategies worth considering. We’ll briefly outline some of those alternatives below.

• Hard money loans: Hard money loans are high-interest loans typically secured by a property and funded by private investors and companies.
• Seller financing: The seller takes the place of traditional mortgage lenders and offers to finance the buyer, and the buyer repays the seller in installments. Seller financing generally offers more flexible loan terms but has higher interest rates and requires larger down payments.
• Peer-to-peer lending: Peer-to-peer loans (P2P) are personal loans and don’t require an asset to secure the loan. The loans are funded by individuals or groups of investors instead of traditional financial institutions. You may get lower interest rates and more flexible terms if you have excellent credit.
• Self-directed IRAs: You may be able to tap into your retirement savings to purchase an investment property. However, you must repay the loan within 5 years. If you don’t, you may owe income taxes and face potential penalties.

Taking Out A Home Equity Loan To Buy Another House: FAQs

To fund a property purchase, should I get a lump-sum home equity loan, a HELOC or a cash-out refinance?

A home equity loan offers borrowers a one-time, lump-sum payment. A home equity line of credit (HELOC) works like a credit card and has a revolving credit limit. During the HELOC’s draw phase, you can access funds, as needed, for any purpose. While HELOCs can offer more flexibility than home equity loans, they have higher closing costs and variable interest rates, which may mean paying more over time. Rocket Mortgage^® doesn’t currently offer home equity lines of credit.

Another option to consider is a cash-out refinance. With this financing option, you take out a larger mortgage that pays off your original mortgage and allows you to pocket the remaining balance in cash. Because it’s a refinance, not a second mortgage, a cash-out refinance won’t create an additional mortgage payment, but it can extend the term of your loan.

There’s a lot to consider when choosing between a HELOC and a cash-out refinance. If you need a lump sum for a down payment or a large expense, a cash-out refinance or home equity loan will probably make more sense.

When can I sell my house after I take out a home equity loan?

There’s no set time limit to sell your house after taking out a home equity loan. However, you must pay off any liens on the home before you can sell the property, including your home equity loan because your home acts as collateral for the loan.

If you sell while you’re still making payments on your primary mortgage and home equity loan, you’ll have to pay off both liens with the proceeds from the home sale. For example, suppose you sell your home for $350,000 and owe $150,000 on your mortgage and $50,000 on your home equity loan. What you owe on the liens will be deducted from your proceeds, leaving you with $150,000 in profits.

Will a home equity loan put my mortgage underwater?

An underwater mortgage happens when a home loan’s principal balance exceeds the home’s appraised value. This scenario typically occurs when a property’s value falls as a homeowner repays their mortgage. While it’s not likely a home equity loan will directly lead to an underwater

The Bottom Line: Taking Equity Out Of Your Home To Buy Another House Comes With Risks, But It’s A Solid Option

Can you use home equity to buy a second home or an investment property? The answer is yes. But while this financing option offers some significant benefits, there are some potential risks. To help ensure financial success, we recommend analyzing all pros and cons before taking action.

If you’re interested in accessing your home’s equity or lowering your mortgage payment, visit our Learning Center to learn more about refinancing.