If you’ve owned a home for the past few years, you’ve likely seen a significant increase in your home’s equity. There are several ways you can tap your home equity to fund other purchases or even an upgrade to a new home. A key way to use your current home’s equity to buy another home through a home equity loan. With this type of loan, you’ll receive the funds as a lump sum to use as you wish—such as to purchase a second home or investment property.
However, using a home equity loan to buy another house also comes with risks. Just like a regular mortgage, a home equity loan uses your home as collateral—meaning the bank could seize it if you severely default on your payments.
Additionally, each lender has its own eligibility criteria when it comes to getting approved for a home equity loan and a mortgage on the second home, if needed. For example, some lenders might not be willing to approve you if you’re using a home equity loan to cover your down payment.
Here are things to consider if you want to use a home equity loan to purchase a new home.
Discover Home Equity
Interest Rate:
Above national average
Minimum Credit Score:
620
Above national average
620
- No application fees, loan origination fees, appraisal fees or closing costs
- Offers cash-out refinancing up to $300,000
- Allows you to borrow against almost 90% of your equity
- Can complete all or nearly all of the application process online
- Only offers refinancing and home equity loans
- Doesn’t offer home equity products in certain states or in any U.S. territories
- Might charge prepayment penalties up to $500 if you repay your loan early
- Takes an average of 6 to 8 weeks to close on a loan
What Is a Home Equity Loan?
A home equity loan is a type of fixed-rate loan that’s secured by your home. You can generally borrow up to 80% of your home’s equity through a home equity loan, depending on the lender.
Unlike with a home equity line of credit (HELOC) that allows you to repeatedly draw on and pay off your credit line, you’ll receive your home equity loan funds as a lump sum. You’ll then pay this amount back in equal installments over your repayment term—usually five to 30 years, depending on the lender.
Because a home equity loan is secured by your house, it’s seen as less risky to the lender—so they tend to offer a lower interest rate compared to other types of loans. Your rate will also depend on other factors, such as your credit, income and debt-to-income (DTI) ratio.
Using a Home Equity Loan To Buy a Second Property
While you can use a home equity loan to buy a second property, it’s important to consider whether you’ll be putting the funds toward another home or an investment property. Here are some pros and cons to keep in mind if you’re buying a second property:
Pros to Using A Home Equity Loan to Buy A Second Home
- Lower interest rates. Because a home equity loan is secured by your house, it will likely come with a lower rate compared to what you’d get with other types of financing.
- Can provide cash for a down payment or an all-cash offer. If you have a large amount of equity built up in your home but don’t have a lot of cash on hand for a down payment or all-cash offer, taking out a home equity loan could be a helpful option.
- No surprise increase in rates. Home equity loans come with fixed interest rates, which means your rate and payment will stay the same throughout the life of the loan.
Cons to Using A Home Equity Loan to Buy A Second Home
- Risk of foreclosure. Using your home as collateral for a home equity loan means the lender could seize it if you don’t keep up with your monthly payments and end up in foreclosure. Missing payments on a home equity loan will also damage your credit score, even if you’re up to date on your primary mortgage.
- Increases your debt load. If you still owe money on your first mortgage, taking out a home equity loan could lead to overextending yourself with debt, especially if you take out another mortgage on the second home. This could make it hard to meet payments if you need to cover unexpected expenses, such as sudden medical costs or loss of employment.
- You’ll likely pay closing costs. Home equity loans come with closing costs just like regular mortgages—usually 2% to 5% of your loan amount. Keep in mind that you might also need to cover additional closing costs if getting a mortgage on the second home.
Using a Home Equity Loan To Buy an Investment Property
Buying an investment property through a home equity loan is different and sometimes more complicated than using the same type of loan for a second home. This is mainly because investment properties are seen as more risky by the lender, so you’ll typically face higher requirements (and costs) when you seek financing for such a property.
Consider these pros and cons before using a home equity loan to buy an investment property:
Pros to Using a Home Equity Loan to Purchase an Investment Property
- Can lower your interest rate. The lower rates offered on home equity loans can help you save money on interest charges, especially if the mortgage rate for the investment property is higher.
- Helps cover your down payment. Since lenders consider investment property loans as riskier compared to traditional mortgages, they sometimes require a higher down payment. A home equity loan can help you come up with enough cash to cover this. Additionally, putting more money down could reduce your monthly payments since you’ll be borrowing less from the mortgage loan itself.
- Could help you more easily qualify for financing. A home equity loan is generally easier to qualify for compared to a mortgage for a second property—especially considering that mortgages for investment properties usually require a larger down payment than a traditional loan.
Cons to Using a Home Equity Loan to Purchase an Investment Property
- You’re adding more debt. To take out a home equity loan, you must put up the equity of the home you own as collateral—this means you’ll be turning an asset into a debt, while also adding more debt through the home equity loan and a mortgage on the investment property, if needed.
- More risk if home values shift. The housing market fluctuates constantly, so if you own two properties and housing values plummet, you could end up owing more on your mortgage and home equity loans. A drop in housing market values could also make it hard to resell the investment property.
- More risk if you default. If you default on your home equity loan, you could lose both the primary home that you used as collateral as well as your investment property if you severely default on all the loans.
- Likely can’t deduct interest. Unless you use your loan funds to build, buy or considerably improve your primary residence that secures the home equity loan, you won’t be able to deduct the interest you pay on the loan from your income taxes.
Alternative Financing Options To Buy Another House
If using a home equity loan to buy another house doesn’t seem like the right fit for your needs, here are some other options to consider:
Cash Savings
If you already have a significant sum squirreled away in a savings account, it might be a good idea to use it as a down payment to avoid taking on more debt.
However, doing so will deplete your cash reserves and could leave you financially vulnerable when it comes to unexpected expenses.
Cash-out Refinance
With a cash-out refinance, you’ll take out a mortgage for a higher amount than what you owe on your home. You’ll then use these funds to pay off your existing mortgage, leaving you with the extra amount—minus any closing costs—to use how you wish.
Keep in mind that you’ll generally need a credit score of at least 620 to get approved for cash-out refinancing—though if you want to qualify for the best rates available, you’ll likely need a score of 700 or higher. Remember that because you’re paying off your old mortgage with a larger loan, your monthly payments will increase.
Personal Loan
A personal loan can typically be used to cover almost any personal expense—including home purchases in some cases. Unlike home equity loans, most personal loans are unsecured, which means you don’t have to worry about collateral.
But because there’s more risk involved for the lender, you’ll likely end up with a higher interest rate on a personal loan than on a home equity loan. Additionally, while you might be able to borrow up to $100,000 or more with a personal loan, depending on the lender, this might not be enough to fully cover the cost of a new home or even a down payment.
Hard Money Loan
If you’re buying an investment property, you might consider taking out a hard money loan. This type of loan is short-term, asset-based financing—meaning it’s secured by real property. To be eligible, the property you’re purchasing typically must be distressed and in some stage of disrepair.
With a hard money loan, the property you plan to buy will be used as collateral for the loan, and your loan amount will depend on how much the lender expects the property to be worth after it’s renovated. Hard money loans also tend to have a much quicker turnaround time, which could make them a good option if you need the cash quickly.
However, keep in mind that these loans are riskier and generally not offered by commercial banks—instead, you’ll have to work with a private company or individual. This added risk to the lender also means that interest rates are usually higher compared to what you’d get with a traditional loan.
