If you have a significant amount of equity in your primary residence, you can tap into it through a home equity loan. You can then use that money for any purpose you wish, including buying another home or investment property. Using a home equity loan to buy another house is not without risks, however, so it's smart to understand the pros and cons before you proceed.
- If you have enough equity in your home, you can use the money from a home equity loan to buy another house.
- Like regular mortgages, home equity loans are secured by your home, so you will be putting it at risk if you're unable to repay the loan.
- There are alternative ways to borrow that may be better in some instances.
Using a Home Equity Loan to Buy Another House
The short answer to the question of whether you can use a home equity loan to buy another house is that yes, you generally can. Bear in mind, however, that some lenders may have restrictions on the source of your down payment and may not be willing to issue a mortgage on the new home if you're using a home equity loan for that purpose. That will not be a problem if you are paying all cash for the new home.
Unlike a home equity line of credit (HELOC), a home equity loan will provide the entire loan amount upfront. The amount will depend on how much equity you have in your home and how much you want to borrow. Most lenders will cap the total amount at a percentage (usually 75% to 80%) of the home's value. Once your home equity loan closes, you'll receive the full proceeds and can then use the money to buy another house or do whatever you want with it.
Pros and Cons of Using a Home Equity Loan to Buy Another House
The major advantage of using a home equity loan to buy a second home is that it may be your best (or only) significant source of funding if you find yourself house-rich but cash-poor. Another potential plus is that interest rates on home equity loans will often be lower than other forms of borrowing.
The biggest downside of using a home equity loan for buying another property—or for any other purpose—is that you are putting your primary residence at risk because it serves as collateral to secure the the loan. If you find yourself unable make the payments on your home equity loan, the lender could foreclose on your home and evict you.
An additional danger is that by taking on a home equity loan, especially if you still owe money on your first mortgage, you could find yourself overwhelmed by debt if you face an unexpected financial reversal, such as a job loss or big medical bills.
Finally, another downside is that you'll have to pay closing costs on the home equity loan, which could add up to several thousand dollars. You'll also have to pay closing costs on the home you're buying.
Alternatives to Using a Home Equity Loan to Buy Another House
Before you apply for a home equity loan to buy another house, it's worth considering the alternatives. They, too, have advantages and disadvantages.
The best source of cash to buy another house would be money that you have already saved up and don't have any other immediate need for.
Your retirement savings are another possibility. For example, if you have a 401(k) plan at work, your employer may allow you to borrow a portion of it through a 401(k) loan. Like home equity loans, retirement plan loans can be risky. You'll typically need to pay the loan back within five years, or even sooner if you lose your job. If you can't pay it back you'll owe income taxes and possible penalties. You will also have that much less money saved for your retirement years, which could mean financial problems down the road.
If you don't have enough savings to put down toward another home, you might consider a personal loan. You'll pay a higher interest rate than with a home equity loan, but if the personal loan is unsecured, your home won't be at risk if you fall behind on payments.
There are also two other ways to use the equity in your home to buy another house: a cash-out refinance or a home equity line of credit.
A cash-out refinance pays off your current mortgage with a larger one based on the accumulated equity in your home. You can then use the extra cash for other purposes. Of course, you'll now have more debt and your monthly mortgage payments will be higher. These loans also have closing costs that can run into the thousands of dollars.
A home equity line of credit shares similarities with a home equity loan but gives you more flexibility in that you don't have to take the money all at once—which might be useful if you need some cash now for a down payment and expect to need more in a year or two to make some renovations. However, HELOCs typically carry variable interest rates, which make them less predictable than a home equity loan, which usually has a fixed rate.
Can You Use a Home Equity Loan to Make a Down Payment on a Home?
Yes, if you have enough equity in your current home, you can use the money from a home equity loan to make a down payment on another home—or even buy another home outright without a mortgage. Note that not all lenders allow this, so if you're planning to buy the second home with a mortgage, you may need to shop around to find one that does.
How Much Money Can I Get From a Home Equity Loan?
Typically, you can borrow as much as 75% to 80% of your home equity. However, you may have to pay several thousand dollars in closing costs, so you won't walk away from the deal with the full 75% to 80%.
What Are the Risks of Using a Home Equity Loan to Buy Another House?
The major risk of a home equity loan, as with a regular mortgage, is that it is secured by your home. This means if you are unable to keep up with the payments, your lender could seize the home, sell it, and evict you. Instead of a home equity loan, you may also be eligible for an unsecured personal loan, which won't put your house at risk, although it will typically have a higher interest rate.
Which Is Better: A Home Equity Loan or Home Equity Line of Credit?
That depends on what you need the money for. A home equity loan may be better if you need a lump sum of money at a particular time—such as to purchase another home. A home equity line of credit could be better if you don't need the money all at once but expect to spend it in stages. Some lines of credit remain open for as long as 10 years.
From an interest rate perspective, a home equity loan may be safer because its interest rate is fixed, while the rate on a home equity line of credit is variable. Borrowers with home equity lines of credit have some protection in the form of caps on how quickly their interest rate can rise, although that can vary from lender to lender.