You decided you are ready to get in on real estate investing. You have friends that are making money hand over fist and you want in on it too. The problem is that you don’t have any liquid assets; everything is tied up in your home. Can you tap into that equity to buy a house?
The answer could be ‘yes,’ if you qualify. Many lenders don’t ask what you intend to do with the equity you take out of your home. As long as you qualify for the loan, the lender will usually give you the loan. You can then use the money to make a down payment on another home.
Here’s how it works.
Determine Your Equity
First, you’ll need to determine how much equity you have in your home. Typically, lenders allow you to borrow up to 80% – 85% of your home’s equity if you take out a home equity loan or line of credit. So if your home is worth $400,000, you would be able to have up to $340,000 in outstanding debt on the home. The actual amount you can borrow depends on the amount of your first mortgage. Let’s say you still owe $200,000 on your first mortgage. That leaves $140,000 available for you to borrow for the purchase of another home.
Each lender has different requirements regarding how much you can borrow. Because home equity loans aren’t an investor funded mortgage, you can shop around with different lenders and see different requirements. Each bank typically keeps the home equity loans on their own books, which means they can make their own rules.
Determine How You Will Buy the Home
Your next decision is how you will pay for the second home. Whether it’s an investment property or a vacation home, you need financing. If you have enough equity in your primary residence, you can use it all to pay cash for the home. This eliminates the need for any other financing, which can be a blessing since getting a mortgage on an investment property or second home has its limitations.
If you only have enough equity in your primary residence to use the money as a down payment, you’ll need financing for the second home. Again, because the programs are more restrictive, you’ll need to find the program that works for you. It will work in your best interest if you maximize your qualifying factors including:
- Have a high credit score – Typically a credit score over 700 is best
- Have a low debt ratio – You’ll need to qualify for two mortgages and take into account your outstanding consumer debt to qualify. Try minimizing your consumer debt to keep your debt ratio as low as possible.
- Have stable income/employment – The longer you have been at the same job with consistent income, the less risk you pose to the lender.
- Have reserves – Lenders like to see that you have cash reserves on hand in the case of an emergency. Owning a second home means you are responsible or the maintenance and repair of two homes, which can mean financial destruction if you don’t have the financial assets available.
- Large down payment – This is where your home equity loan can help. The more money you invest in the second/vacation home, the less risk you pose to a lender. If you can make a down payment of 30% or more, you’ll be in better shape to get the loan approval.
Make Sure you Can Afford It
Just because you can use your home’s equity to buy another home doesn’t mean you can afford it. Remember when you take out a home equity loan, you’ll have two mortgage payments to make on your current home (if you still have a first mortgage) plus you’ll have the financing on your second/vacation home.
As we stated above, owning more than one home can be financially draining too. You’ll need to make sure that you can afford the repair and maintenance on the properties to keep yourself in good financial shape. There’s no sense in getting in over your head if you don’t have the cash reserves available to help you when the hot water heater breaks or you need a new roof on the home.
Buying a second home with your primary residence equity is possible, but you should exercise caution. Make sure you are in financial shape to afford both mortgages and can handle the maintenance and repairs required when you own two homes. Owning another home can be a financially intelligent move, but you have to go about it the right way.Click to See the Latest Mortgage Rates»