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Can I Use a Home Equity Loan To Buy Another House?
By Joan Pabón MONEY RESEARCH COLLECTIVE
Home equity loans and lines of credit are incredibly flexible products; not only do they offer competitive interest rates, but you can also use the funds for any purpose, from remodeling your home and funding long-term expenses to covering emergencies and even putting money down on another home.
Table of Contents
- What is a home equity loan?
- How to use a home equity loan to purchase a new home
- Using a home equity loan to buy another home FAQs
- Summary on our guide to using home equity loan to purchase a new house
What is a home equity loan?
A home equity loan, also called a second mortgage, is a financial product that uses your home as collateral and allows you to access the equity in your real estate property. There are two main types of home equity loan products:
Home equity loans
Home equity loans, also called second mortgages, are fixed-rate loans that provide you a lump sum of money based on your tappable equity, the number of liens on your home, your debts and other financial and property details. Loan terms for these products range from five to 30 years and rates are competitive compared to credit cards, personal loans and even investment property loans.
Since home equity loans provide you with a lump sum of money and feature fixed interest rates, this funding option may be best suited to large one-time purchases.
Home equity lines of credit (HELOC)
A home equity line of credit (HELOC) is a revolving loan that, in some ways, works similarly to a credit card. With a HELOC, you get a maximum line of credit from which you can draw funds as needed during a specified “draw” period, typically five to 10 years. You can use whatever amount of money you need (up to the limit), repay it and borrow again. Many lenders also allow you to make interest-only payments during the draw period.
After that initial period, you enter a repayment period that typically lasts 15 or 20 years, during which you cannot use your line of credit and have to make both interest and principal payments. Most HELOCs have variable interest rates that are subject to change based on the prime rate. If rates increase, so will your loan payments.
HELOCs are best for borrowers who have ongoing expenses, like long-term home improvement projects. And if you are wary of the variable nature of a HELOC, some lenders offer the option to lock in a fixed rate on some or all of the HELOC amount.
Read our article on the best home equity loans to explore these and other options.
How to use a home equity loan to purchase a new home
If you’re thinking about purchasing a new property with the equity in your current home, consider the following:
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The cost of the property
With a home equity loan, you could be able to borrow between 80% and 85% of the value of your current home. Depending on how much that is, you may or may not be able to afford the purchase of the second home without the need for yet another form of financing. That could leave you with three loans: a first mortgage, a second mortgage and another type of loan.
With this in mind, purchasing a second property with your home equity may not be advisable for all borrowers.
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The type of property
If you are planning to use a home equity loan to purchase or make a down payment on a vacation home, make sure you’re in a very stable financial situation that’s unlikely to change in the near future.
It makes the most sense to use home equity to purchase another home when that property is going to be an investment, either a home you can update and resell or one you can rent out. And even in that scenario, there are things to keep in mind, particularly your return on investment.
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The return on investment
When getting a home equity loan to purchase an investment property, you’ll first want to calculate your potential return on investment (ROI). And, in the case of real estate, there are different ways of doing so.
For example, most ROI calculations presume you are purchasing a home either in cash or through a mortgage. If you’re buying cash and plan to resell the home, the calculation is simple enough: you take your net profit (what you can make if you resell the home), subtract your total investment (the cost of the home plus repairs), then divide that by the total investment and convert the result into a percentage.
But if you are using a home equity loan to cover the home purchase price either in whole or in part, the calculation becomes more complex — particularly if you’re getting a third loan or plan to keep the property as a source of rental income. In that case you would also need to account for monthly payments on your loan (or loans) and operating expenses if you’re renting out the unit.
The following are just some of the variables you need to factor in when performing an ROI calculation for an investment property:
| If you're planning to resell the home | If you're planning to rent out the home |
|---|---|
The projected future value of the home based on comparable homes in the area | The annual revenue the rental property can generate based on median rental costs in your area for units with similar features and finishes |
The total cost of the home plus repairs and expenses (for cash offers) | Operating expenses, including management fees, maintenance costs, repair costs, landlord insurance, property taxes, etc. |
Out-of-pocket costs, including the down payment, closing costs, repairs, etc. (for financed purchases) | Monthly payments or interest on your loan or loans (for financed purchases) compared to monthly rental income
|
In all scenarios, we recommend you hire a trusted financial advisor to help you run the numbers and make sure you’re making the right decision based on your finances.
Consulting an expert will be especially helpful when deciding the minimum ROI you’d be comfortable with based on your risk tolerance. Some sources claim an ROI of over 15% is a good investment if you’re doing a simple calculation (buying in cash), while others say anywhere between 8% and 10% is acceptable if you’re financing the property, but there is no fixed rule.
Pros and cons of using home equity to purchase a new home
As with any financial decision, there are advantages and disadvantages to using home equity to purchase a new home. Of course, the main downside of using your equity for this purpose is that failing to keep up with your loan payments could put both your primary residence and your second home at risk of foreclosure.
- You could get a lower interest rate than with other forms of financing
- You could increase your buying power without depleting your savings
- Purchasing an investment property could help you turn a profit
- Home equity loan rates are higher than mortgage rates
- Tapping into your equity will reduce your home value
- You could end up with two other loans plus your existing mortgage
- You could lose your primary residence and second home to foreclosure
How much equity do you need to get a home equity loan?
Most lenders require you to have at least 20% equity in your home — or a loan-to-value ratio of 80% — to qualify for a home equity loan or line of credit. The amount of equity you have on your home (among other factors) will determine the loan amount for which you could be approved.
Besides tappable equity, lenders will also require a good credit score, proof of employment, income and assets, a low debt-to-income ratio and certain property characteristics. For example, some lenders will not issue loans secured by properties in need of repair.
Can I use a home equity loan to buy another house FAQs
Can I use my house equity to buy another house?
The short answer is yes, you can use a home equity loan to buy another house. Depending on your situation, the more advantageous scenario could be to purchase a house you can renovate and resell to turn a profit or from which you can generate rental income.
Unless you are an experienced real estate investor, we recommend consulting a financial planner before purchasing an investment property using a home equity loan.
Can you use a home equity loan for anything?
Yes, you can use a home equity loan for any purpose, but just because you can doesn't mean you should. Some of the best ways to use home equity include making home improvements that will increase the value of your home and build more equity, paying off high-interest loans and setting up an emergency fund.
Can you use home equity to pay off another mortgage?
Technically, yes, you can use a home equity loan or line of credit to pay off your mortgage. If your reason to do that is lowering your monthly payment or getting out of an adjustable-rate mortgage, then a mortgage refinance loan may be a better option. To determine which type of loan is right for you, compare current refinance and home equity loan rates as well as closing costs on both loans.
What if I don't have enough equity in my home?
There are several things you can do to build equity in your home, including staying on track with your monthly mortgage payments, paying extra toward your loan whenever possible and making home improvements that can boost the value of your home.
Of course, your home's market value could increase without you doing anything if home prices in your area have increased due to high demand and short supply.
What are the benefits of using home equity to buy another house?
Using a home equity loan to buy another house, especially if the second home is an investment property, could help you generate a profit. Home equity loans have more competitive rates than other loan options, like personal loans, and closing costs may also be more affordable.
However, if you can't make your monthly payments, the risk of foreclosure is high and you could end up losing both homes.
How can I get equity out of my house?
You can get equity out of your house by selling it. If that's not in your plans, you can tap into your equity through a home equity loan, home equity line of credit (HELOC) or cash-out refinance loan. These options are available to homeowners who have sufficient tappable equity, regardless of whether they have a first mortgage or already own their home in full.
Summary of our guide to home equity loans to buy another house
If you’re financially stable and likely to remain so for the next 10 to 30 years, using home equity to fund another home purchase could be a good investment, especially if you plan to generate income from that second property by either reselling for a profit or renting it out.
Using a home equity loan for this purpose isn’t without risks, however. The main one being that you could end up biting off more than you can chew trying to keep up with several monthly payments at once. And if you can’t pay your loans, you could lose your primary home along with your second property.
Before investing in real estate or anything else, consult a financial expert that can help you make the best choices based on your goals.
Joan is a professional translator, writer and editor with a special interest in personal finance and insurance topics. She has been a contributing author and independent researcher at ConsumersAdvocate.org since 2017 and an editor at Money since 2019. Her work has been featured in MSN Money and Apple News.