If you’re a Wasatch Front homeowner looking to buy a second property, the equity you hold in your original property can be a powerful way to fund your purchase or cover some of the costs associated with buying a rental or investment property.
Here’s how to use existing home equity to purchase a new home.
Unlocked: Using Home Equity to Buy a New Home
Your home is your biggest asset, and the best thing about it is that an ever-increasing chunk of the money you spend on your mortgage goes right back into your pocket in the form of equity. That’s the share of your home’s value that you have already paid for.
Let’s take a look at how to tap the equity you already hold in your residence to fund a new home purchase or to cover the costs of a remodel. We’ll also discuss some of the advantages and potential risks and consider whether this approach is right for you.
Home Equity Loan or HELOC?
You can access the equity you already own in your home in two ways: a home equity loan or equity line of credit (HELOC).
Home Equity Loans
A home equity loan is also known as a second mortgage. It allows you to borrow a single lump sum against the equity you have already built up in your home, and to repay this while continuing to make payments on your original mortgage.
A home equity loan can be an effective way to fund a second home purchase:
- It provides a single lump sum for a down payment
- Interest rates are fixed and relatively low
- Loans can be repaid over 20 years or more
- You can borrow up to 80% of the value of your equity
- Interest on a loan spent on purchasing a home is tax deductible
Using a home equity loan to purchase a second property also comes with some serious potential risks:
- You will need to pay down significant debt on three separate loans
- You will likely wipe out all or most of the equity in your existing home
- By securing one home purchase against another, you risk losing both properties if you’re unable to make payments on all your loans.
A HELOC also allows you to borrow against existing equity in your home but in the form of a revolving line of credit similar to a credit card rather than a single lump sum. HELOCs offer many of the advantages of a home equity loan, such as a long repayment period and tax-deductible interest when used to fund home expenses. They also:
- Allow you to borrow only what you need, when you need it
- Allow you to borrow up to 85% of the value of your equity
- Often feature a zero or low-interest initial borrowing period
- Are cheaper and easier to qualify for than home equity loans
At the same time, HELOCs can be a risky way to borrow money, because:
- Interest rates are usually not fixed, so your payments can rise over time
- It’s easy to over-borrow during the initial low-interest period
- After the initial borrowing period, rates reset at a far higher APR
How to Tap Your Home Equity
Whether you choose a home equity loan or a HELOC, the steps to tapping your home equity for a second home purchase are similar.
1. Calculate Your Equity
Your equity is the value of your home less what you still owe on your mortgage. Most lenders will not let you borrow more than 80-85% of the value of your equity.
2. Talk to Lenders
Talk to your original mortgage company and others. Find out how much they will be willing to lend you and on what terms. Consider local credit unions who often offer better rates, and will take the time to get to know you personally and understand your financial goals when considering offering a loan. Apply for pre-approval from 2-3 lenders.
3. Check Your Credit
Take a hard look at your credit score. Lenders may be wary of allowing you to secure the purchase of a second home against an existing home mortgage. You’ll need excellent credit and strong employment prospects. Remember that borrowing more will also significantly lower your score.
4. Complete an Application
Gather documents including proof of identity, income, assets, and liability. You’ll also need to provide information about your existing home loan, employment, and other debts and alternative sources of funding. Complete your paperwork.
5. Pay Fees and Closing Costs
You’ll need to pay for an assessment of the value of your existing home, as well as loan origination, processing, and other fees. Once approved, you’ll have to pay closing costs of 2-5% of the value of your loan.
6. Receive Your Lump Sum or Line of Credit
Use the money to help fund the purchase or offset the costs of buying a second home.
Should I Use Home Equity to Buy a New Home?
Home equity can be an effective way to purchase a second home, especially if you have already built up significant equity in your first home. The best way to do this is through a home equity loan that provides a large lump sum at a fixed rate of interest.
It can be tempting to use the initial low-interest rates offered by many HELOCs to fund a down payment on a second property, but you’ll likely end up paying more in interest once the rates reset. HELOCs can be useful when buying a second home to help fund closing costs, pay down points on a conventional home equity loan, or fund upgrades on your new property.
Interest on both home equity loans and HELOCs is tax deductible (up to a limit) when the loan was used to purchase or improve any property, but the rules become more complex when the money is used on rental, investment, or mixed-use properties.
Open More Doors With Wasatch Peaks Credit Union
Northern Utah is a great place to put down roots. We've got you covered if you’re looking to expand beyond your original home with a cabin, condo, or even a rental.
At Wasatch Peaks Credit Union, we know an opportunity when we see it. Our generous home loans and home equity loans continue to open new doors for families throughout our area. And our flexible home equity lines of credit allow you to use the stake you already own in your home to unlock new opportunities by:
- Consolidating debt
- Paying off credit cards
- Freeing up cash to remodel your home or rental property
Talk to us today to find out how a Wasatch Peaks HELOC can unleash your equity. Click below to learn more.