A home equity loan is a way to tap into the equity that you may have in your primary residence. The money can be used for whatever purpose you choose, such as buying a second house or investment property. There are risks in using a home equity loan for another house purchase. It is important to understand the pros and cons before deciding fully.
KEY TAKEAWAYS
- You can borrow money from your home equity to purchase another house.
- The home secures home equity loans.
- You may have other options to borrow money that might be more suitable in certain cases.
Using a home equity loan to buy another house
You can generally use a home equity loan to purchase another house. Keep in mind that lenders might have restrictions about the source of your downpayment and may not allow you to get a mortgage for the new house if you use a home equity loan. This will not be an issue if you’re paying cash for the home.
A home equity loan can pay the entire amount upfront, unlike a Home Equity Line of Credit (HELOC), which offers a revolving credit line. The amount you borrow will depend on the equity in your home and its market value. The loan amount will be affected by your income and credit history. Lenders will limit the amount to a percentage of the home’s worth, usually 85%. The home equity loan will close, and you’ll get the entire proceeds. You can then buy another house, or do whatever else you wish with the money.
The Pros and Cons to Using a Home Equity Loan to Purchase a Second House
A home equity loan is a great way to purchase a second house. It may be your only or best source of financing if you are cash-poor but have the money. The best part about home equity loans is the lower interest rates than other borrowing options, but they are usually higher than mortgage interest rates.
The downside to using a home equity loan to buy another property or for any other purpose is that your primary residence will be at risk as it is used as collateral for the loan. The lender can foreclose your home and force you to pay the home equity loan payments if you are unable.
There is a risk that you might become overwhelmed by debt by taking out a home equity loan. This is especially true if your first mortgage is still outstanding. You may end up being obligated to repay three mortgages simultaneously: your mortgage on your primary residence, your mortgage on the second house (if the loan isn’t sufficient to purchase the house), and your home equity loan.
Another downside to the home equity loan is the closing cost, ranging from 2% to 5% of your total loan amount.
Other Options to Using a Mortgage Equity Loan to Purchase a House
It’s worth looking at other options before applying for a loan to purchase a house. Both have their advantages and disadvantages.
Cash
You have the money you already have and have no immediate need for cash. This is the best way to get cash to purchase another house. You shouldn’t apply for a loan if you don’t have this.
Retirement savings
You have the option to use your retirement savings. Your employer might allow you to borrow some of your retirement savings through a loan. Retirement plan loans are risky, just like home equity loans. The loan must be paid back within five years, even if your job is lost. You’ll be responsible for income taxes and penalties if you don’t repay the loan.
Borrowing from your 401 (k) will reduce your savings for retirement, which can lead to financial difficulties down the line.
Personal loan
A personal loan is an option. A personal loan could be an option. Although you will pay higher interest than a HELOC or home equity loan, your home won’t become underwater if you default on your payments.
Cash-out refinance
Cash-out refinances to pay off your existing mortgage by replacing it with a larger loan based on your equity. The extra cash can be used for other purposes. You’ll have higher monthly mortgage payments and more debt. Closing costs for these loans can reach thousands of dollars.
Home Equity Line of Credit (HELOC).
A HELOC can be used to purchase an investment property, rental property or second home. It allows you to have more flexibility than a home equity loan. If you require cash now to pay a downpayment and plan to use the money in the future to fund renovations, this might be a good option. HELOCs are more unpredictable than home equity loans with a fixed interest rate.
Reverse mortgage
While there aren’t many people over 62 who want to be landlords, it is possible to get a federally-insured home equity conversion mortgage (HECM), also known as a reverse mortgage, to purchase a rental property that will provide an income stream for your retirement years.
A HECM is a way to convert the equity in your house into cash. This cash is usually tax-free and does not affect your Social Security or Medicare. You don’t pay any monthly mortgage payments, and the lender pays you the money. You don’t have any monthly payments on the mortgage, but you won’t be required to pay it off as long as the house is your residence. You, your spouse or your estate will have to pay off the mortgage in full. Plus interest at a variable rate. This accrues over the loan’s life and takes up equity.
This means that you will have to pay a large sum if you plan to leave your home to your heirs. The reverse mortgage could be paid off if your rental property is sold.
A Home Equity Loan can be used to make a down payment on a home.
If you have enough equity in your home, you can borrow money from home equity to pay down a mortgage or buy a new home. This is not possible with all lenders. If you are looking to purchase a second home without a mortgage, it may be worth shopping around.
What is the Maximum Loan You Can Get from a Home Equity Loan?
You can typically borrow up to 85% of your equity. You may need to pay closing costs up to several thousand dollars so that you don’t get the 85 spans.
What are the risks of using a home equity loan to buy another house?
As with regular mortgages, the main risk associated with a home equity loan is secured by your house. Your lender can seize your home and sell it if you fail to pay. You may also be eligible for an unsecured personal loan instead of a home equity loan. This will not put your home at risk, but it will usually have a higher interest rate.
Which is Better: A Home Equity Loan or a Home Equity line of credit (HELOC)?
It all depends on the reason you need the money. If you require a large amount of money quickly, such as to buy another house, a home equity loan might be better. If you don’t have the cash immediately but plan to use it over time, a home equity line-of-credit (HELOC) may be a better option. Some credit lines can be open for up to 10 years.6
A home equity loan is more secure than a HELOC because it has a fixed interest rate. HELOC borrowers have some protection because they can limit how fast their interest rates may rise. However, this can vary from lender to lender.
