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Want to use HELOC to buy a second home? You can utilize the equity on your home to buy another house depending on the purpose of the second property. For example, if you’re interested in buying an investment property, taking out a home equity line of credit HELOC may be beneficial for you. However, keep in mind that this course of action may have certain advantages and disadvantages.
Like any other loan – whether a home equity loan, a personal loan or a cash-out refinance, a HELOC too comes with its benefits and drawbacks. And to help you make an informed financial decision, we’ve listed the pros and cons of using your home equity to buy a second house. You can then decide if it’s right for you or not.
Why use HELOC to buy second home?
Having a second home or a vacation home is a dream for many homeowners. However, getting a mortgage to buy another real estate can be a challenge. The minimum loan eligibility requirements are generally more stringent than a mortgage that’s taken to buy a primary residence.
If you have a good amount of home equity in your current residence, you can tap into it through a HELOC and use the money for buying a second home or an investment property.
Do keep in mind that such a loan type is not without its associated risks – a foreclosure in the event of a loan payment default being the most disastrous one.
Can you use HELOC to buy second home?
The answer is yes, you generally can. However, some HELOC lenders may have restrictions and may not be willing to allow you a mortgage on the new home. You can always check with the bank, financial institution, or individual mortgage lender.
If you meet the requirements, a HELOC will provide you with a revolving line of credit – the loan amount of which will depend on the home equity you have, and your house’s market value (most lenders cap the loan amount to 85% of the home’s value), how much you want to borrow, and for what purpose.
Other factors that will affect the loan amount are your income and credit history. Once you get the loan, you can use the funds to buy another home.
Can I use the loan to make a down payment on the second home?
Yes, you can use the money from your HELOC to make a down payment on another home – provided you have enough equity in your current home. Having said that, not every lender may allow it. Therefore, if you’re planning to buy a second home with a mortgage, it’s best to shop around keeping this in mind.
Read more: How long does HELOC take?
Pros and cons of using HELOC to buy a second house
The most significant advantage of using a home equity loan to buy a second home is that it’s a good source of funding. And, you get to save cash for your emergency funds.
Another potential benefit is that HELOC interest rates are often lower than other forms of borrowing.
The biggest drawback of using a HELOC for buying another property is that you end up putting your home at risk as it’s the collateral used to secure the loan. If you’re unable to make the monthly payments on time, your loan lender could foreclose on your house and evict you.
Another problem is that with multiple loans, you might find yourself in deep debt – especially if you still owe a lot of money on your first mortgage. On top of that, you’ll need to pay hefty closing costs, which could be 2% to 5% of the total loan cost. A sudden job loss or an expensive medical bill could make your financial situation topsy-turvy!
Another possibility is that the real estate market conditions may change – depreciating the value of your home. In such a case, you will owe more on your home than it’s worth.
Alternatives to using a HELOC
Before you buy your second home, you may want to consider the alternatives.
Pay in cash
If you’ve saved enough, and have no immediate need for it, paying by cash is one of the best ways to buy another house. No borrowing, no interest rates, and no repayments!
Using your retirement savings
You can utilize a part of your retirement savings through a 401(k) loan. However, keep in mind that you’ll need to pay back the loan within five years. And, you cannot afford to lose your job. If you fail to pay back the money, you’ll end up owing a hefty income tax and possible penalties.
Also, borrowing against your retirement will mean that much less money for your retirement years.
If you’re unable to get a HELOC, you could consider applying for an unsecured personal loan. However, you’ll be paying a higher interest rate than a home equity loan interest rate.
Read more: Home loan information
Through a cash-out refinance, you can pay off your current mortgage with a larger one based on your home’s value. You can then use the extra cash to buy a house that fits into your budget. Of course, you’ll have more debt, higher closing costs, and higher monthly mortgage payments to pay.
If you’re older than 62 and looking to buy a rental property that can provide you with a steady income, you could take out a federally insured home equity conversion mortgage (HECM).
It converts your home equity into cash. And, is usually tax-free. Moreover, it doesn’t affect your Social Security and Medicare. As long as you live in that house, you don’t have to pay off the mortgage. But if you move out, sell the home, or die – you or your heirs must pay off the mortgage in full, including the total interest over the life of the loan.
Read more: Can I use my 401k to buy a house ?
You can use a fixed-rate home equity loan and HELOC (with a variable interest rate) to buy another house – successfully reducing your out-of-pocket expenses. Of course, you must have enough equity in your home. Do keep in mind that this step comes with certain risks. You’ll not want to put your precious home at risk if you’re unable to repay the loan. But, if you have a solid loan repayment plan in mind, you may go ahead with the loan application. Just be doubly sure before tapping into your home equity.
Read more: How long is option period
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