How to Use Equity to Buy a Second House
In competitive real-estate markets, it is important to have easy access to funds while purchasing a second home. A home equity loan is a low-cost, convenient way to facilitate this purchase and cover a large portion of your down payment.
Ways to Use Home Equity to Buy a New Home
Conventional home equity loans, home equity lines of credit (HELOCs) and cash out refinance are the primary ways to access home equity to put towards a second home. Many borrowers use a home equity loan to fund the down payment on the second house.
Calculate your home equity by subtracting your current mortgage balance from the current value of your home. If the current value of your home is $400,000 and you owe $300,000 on your mortgage, your home equity is $100,000. You may be able to use a portion of this equity through a home equity loan for a down payment on a second home.
Your combined loan-to-value (CLTV) ratio helps lenders assess the amount that they are able to lend you. Calculate your CLTV by dividing the total of your mortgage amount, the new loan, and any additional loans that you have against your home by the current value of your home. If the current value of your home is $400,000 and your combined loans total $300,000, your CLTV is 75%.
Many lenders will only offer home equity loans for a CLTV up to 80%, while Discover Home Loans offers home equity loans for less than 90% CLTV. This maximum CLTV is to protect the lender from distributing a loan to a homeowner who could owe more on mortgage loans and home equity loans than their house is worth.
1. Home Equity Loan
A home equity loan is a lump sum of money you can borrow, using your home equity as security. Home equity loans typically have a fixed interest rate and fixed monthly payments over a fixed term of 10-30 years.
Since home equity loans are one-time, large deposits, they may be useful for putting a down payment on a second home or funding a large remodeling project. Use our Loan Amount Calculator to see the maximum amount you may be eligible to borrow for a home equity loan.
Discover Home Loans offers home equity loans from $35,000 to $200,000 with low fixed rates and zero origination fees.
A HELOC is a line of credit with a monetary limit, which you can access as needed for a second home loan. There is a fixed draw period during which funds can be withdrawn. There is also a fixed repayment period, commonly 10-20 years, during which the borrower finishes repaying the loan. Since HELOC interest can sometimes be variable and dependent on national economic factors, monthly payments may fluctuate and may increase as the repayment period progresses.
HELOCs may come with extra charges such as closing costs and application fees.
HELOCs may also come with transaction fees and annual fees from the lender.
HELOCs are useful for financing projects spread over the course of years that have flexible costs.
While Discover Home Loans does not currently offer a HELOC, Discover does allow you to refinance a HELOC into a new home equity loan that offers fixed rates from 3.99% - 11.99% APR*.
3. Cash Out Refinance
Cash out refinance involves rewriting your mortgage loan for a larger amount than you already owe. You can then take that extra money in cash and repay it along with your mortgage. If you have a $300,000 mortgage and you want to borrow $150,000 to buy a second home, you could potentially refinance your original mortgage loan for the combined $450,000 to do so.
Cash-out refinancing is useful if you already want to change your mortgage because interest rates have dropped, or the repayment term has decreased. Use our Cash Out Refinance Calculator to see how much cash you can get out of your home.
Discover Home Loans offers mortgage refinance loans from $35,000 to $200,000, with zero origination fees. This can be a tremendous savings, considering that typical refinance loans require average fees totaling 2% to 5% of the total loan.
Home equity loans can provide you with a large lump sum of money for a down payment on a second house
Using Equity to Buy a Second Home: Advantages
Using home equity to purchase a new home can be advantageous since home equity loans are secured loans and are available for lower interest rates and higher borrowing limits than many unsecured personal loans.
1. Tapping into home equity helps capitalize on standing assets with minimum risk
By using home equity to buy a second home, you can pull from a stable source of money and reduce the risk of affecting your long-term finances. Withdrawing from other sources, such as an investment or bank account, can bring higher risk and make a dent in your current savings.
2. Potential for large down payment
Home equity loans can provide you with a large lump sum of money for a down payment on a second home. This large down payment can pay off in lower interest rates, lower monthly payments and reduced insurance premiums.
3. Home equity loan fixed rates will offer predictability
Home equity loans come with lower interest rates than personal loans because they are secured. Lenders see home equity as a high-quality form of collateral. Home equity loan interest rates are also fixed, so you can build a budget to make consistent monthly payments over a set amount of time.
4. A second home can diversify your assets
As opposed to taking cash from savings or an IRA, taking equity out of your home to buy another house builds on existing real estate assets. You can continue to diversify your portfolio as your assets appreciate in value.
Explore Discover Home Loans to find the best solution for you.
Using Equity to Buy a Second Home: Disadvantages
While low fixed interest rates, high borrowing limits and steady payment schedules can make home equity loans appealing when buying a second home, there are some risks with this strategy.
1. If you are unable to repay loan, you risk losing both homes
If you use a home equity loan or refinance your original mortgage to purchase your second home, you are putting both your primary residence and second home at risk of foreclosure. When you default on a loan, the bank may have the ability to foreclose on your home to recoup the full value of the loan.
A second home also expands your pool of risk: if either of your homes’ value falls in a depressed market, you may find that the decreasing home value will have you owing more on your mortgage and home equity loans than the homes are worth at sale. If you are not planning on selling either home and can continue to afford monthly payments, this may not be a problem, but if you find yourself trying to sell either home, reduced market values could affect your ability to repay the loans.
2. May prevent refinancing of first home’s mortgage loan
Having a second home loan on your primary residence may prevent you from refinancing your original mortgage loan. Some lenders will not allow refinancing until the second loan is completely repaid.
3. Funds from home equity loan may not be tax deductible
Home equity loans and HELOCs may allow you to deduct the interest payments you make against the loan, but only when the funds from the loan go towards substantial home improvements. When you use a home equity product to finance payment towards a second home, your interest payments will not be eligible for tax deduction.
4. HELOC variable rates may fluctuate your monthly payments
If you use a variable rate HELOC to finance your second home purchase, you will likely see the monthly payments for the HELOC move up or down over the life of the loan. Some HELOCs typically can use a variable rate (as compared to the fixed rate of a home equity loan), which is pegged to a national economic rate (usually the U.S. Bank Rate but check with your lender to understand which rate affects your HELOC rate). While some HELOCs may permit converting to a fixed rate, you should expect to pay additional fees for this service.
Alternatives to Using Equity to Buy a Second Home
A down payment of at least 20% will help avoid the additional expense of private mortgage insurance. Using a home equity loan for down payment on a new home can be considered as the most obvious choice, but there are other ways to finance the purchase of a second home.