Do you have your eye on buying a second home, but don’t have the down payment or funding? If you have equity in your current home, you may just have the funds you need. As long as you qualify for a home equity loan, you may use the funds to buy a second home.
Is it wise? We explore the answer below.
Financing a Second Home is Hard
Banks are somewhat lenient when providing funds to buy your first home. It’s your home to live, so there’s a lower risk of default. If you meet the credit score, income, asset, and debt ratio requirements, you may get the loan.
If you have your eye on a second home, though, lenders are a bit pickier. Second homes aren’t where you live. If you run into financial trouble, you’ll likely stop paying the mortgage on the second home. You won’t be homeless if you lose this home. Your primary home is the one of most importance to you.
Because of this, lenders have stricter credit score, income, asset, and debt ratio requirements. Many people find that they don’t qualify to buy a second home despite having the money to do so.
Using Your Home’s Equity
If you can tap into your home’s equity, it gives you a larger down payment for the second home. Lenders like to see ‘skin in the game.’ The less you borrow compared to the home’s value, the less risk of default you pose.
For example, if you put $100,000 down on a home, you are likely to do what it takes to keep up with your mortgage payments. If you don’t, the bank has plenty of equity in the home. This minimizes their losses when they sell the home at auction.
If you only put $10,000 down, though, your chances of default increase. It may be easier for you to walk away from the home if you can’t afford the payments. This leaves the bank in a much more difficult situation. There’s very little equity in the home, which typically means a loss for them, even after selling the home at auction.
In some cases, borrowers have enough equity in their home to pay cash for their second home. You wouldn’t even have to deal with trying to get financing for a second home. Home equity loans are much easier to get.
The Benefits of the Home equity loan
Home equity loans are tied to your primary residence. Applying for it is usually much easier than applying for a loan on a second home. Lenders look at your:
- Loan-to-value ratio
- Credit score
The lender needs to know that you can make both mortgage payments (first and second), if you still have a first mortgage. Interest rates on home equity loans are typically much lower than mortgages for a second home. If you have enough equity (you can usually borrow as much as 85% of your home’s value), you won’t have to worry about the second mortgage.
Home equity loans are much less expensive too. The interest rates and closing costs are usually much less than what you’d find on a mortgage for a second home. Lenders don’t have to do as much work for a home equity loan, which cuts down on your costs.
A Second Home Within Reach
If you want a second home, but don’t have the liquid funds, your primary home be a great source. Figure out how much equity you have in your current home. Talk with a licensed real estate agent or pay for an official appraisal on your home. This way you know its actual value. From that value, subtract any outstanding financing you currently have.
For example, let’s say an appraiser says your home is worth $400,000 and you have $50,000 left on your current mortgage. You have equity of $350,000. While you can’t take all of it, you may borrow as much as 85% of the value, which is $340,000. Take off the $50,000 outstanding mortgage and you have $290,000 available in a home equity loan, as long as you qualify.
Using a home equity loan can be a great way to buy a second home. Explore your options and compare them side-by-side with a second mortgage, if you are eligible. You’ll likely find much better interest rates, closing costs, and even underwriting guidelines.