A home equity loan is one of several methods you can use to buy another home. Funds you get from a home equity loan are deposited into your bank account, so they can be used for a number of expenses related to the purchase of another property. You can use it for the down payment, closing costs, and any repairs or upgrades you might want to make after the purchase is finalized. So if you are looking to use a home equity loan to buy another house, this is the post for you!
With that being said, there are some nuances to be aware of. Read on as we’ll go through the pros, cons, and alternative funding options to consider.
How would I use the funds from the home equity loan for the purchase of another home?
With home equity loans, loan proceeds may be issued to you in a single lump-sum payment and can be used just like any other funds in a checking or savings account. One difference is that the lender financing the property you are purchasing may want to see two months of bank statements to verify the source of funds for your down payment and closing costs.
If you don’t have proof that the funds have been in your account for two months, you’ll need to provide the paperwork from your home equity loan showing where the funds came from.
What are the advantages of using a home equity loan to buy another house?
Using a home equity loan to purchase another property can give you more flexibility and options. Here are some of the things you might benefit from by tapping into your home equity.
You have more buying power with a larger down payment
By using a home equity loan, you can place a larger down payment on another property. This can allow you to buy more expensive real estate or get a smaller loan with lower monthly payments. It can also allow you to meet down payment requirements. Investment property loans, for instance, typically require a larger down payment compared to owner-occupied homes.
However, make sure to factor in the monthly payment on the home equity loan to ensure you can afford all of your housing expenses.
You can buy a property that is otherwise not eligible for financing
If a lender won’t issue financing on a property because it does not meet its lending requirements, you can buy it free and clear with funds from a home equity loan. You’ll need a significant amount of equity to do so, but doing so can allow you to bypass a lender’s typical requirements for the property to be in a habitable condition.
You can get another source of income
Using a home equity loan to acquire an investment property can allow you to get another stream of monthly income. Make sure that your expected return on investment outweighs the costs and potential risks. To do this, you’ll want to factor in all related expenses like your mortgage loan payments, repairs, and maintenance. It may also be a good idea to have conservative calculations for any projected rental income to account for periods of time in which the investment property may be unoccupied.
What are the risks of using home equity loans to buy another house?
The primary risk with is losing both your primary residence and the other property if you can’t afford the payments because, with home equity loans, your house is used as collateral. Missing too many payments could result in the bank foreclosing on your home. Because of this possibility, taking out a home equity loan is not something that should be taken lightly.
If you’re using a home equity loan to purchase an investment property, it’s a good idea to consider whether you can afford both payments if you end up generating less income than expected.
Home equity loans can be more expensive than other types of financing
In addition to having to pay closing costs, home equity loans can have higher interest rates than conventional mortgage loans. Part of this is attributed to the fact that home equity loans are second mortgages and are higher risk for lenders since the loan is junior to your primary mortgage. In the event of a default, lenders will foreclose on a home to recoup some of its financial losses. Lenders holding a second mortgage to a property will only receive funds after the first mortgage holder and other state and federal debts have been satisfied.
It can make refinancing your existing mortgage more difficult
Getting a second mortgage, such as a home equity loan, can make it more challenging to refinance the underlying first mortgage. Doing so would require the company holding the home equity loan to agree to the terms of the new first mortgage, a process referred to as a subordination agreement. Lenders will also factor in your payment on the home equity loan to determine if you can afford the payments on a new first mortgage for a refinance.
Can I use a home equity line of credit (HELOC) or a cash-out refinance to buy another property?
This is something you can do, although we wouldn’t recommend it for a HELOC. HELOCs are similar to home equity loans in the sense that they are also a second mortgage on your property, but interest rates are almost always variable compared to the fixed interest rates on most home equity loans. This means that your payments could potentially increase. If this happens and you can no longer afford the monthly payments, you risk losing your home to foreclosure.
With a cash-out refinance, you’ll have options for fixed interest rates, so it carries less risk. However, you’ll still want to make sure you can afford the monthly payments so as not to run the risk of foreclosure on your primary residence.
How would I get a home equity loan for the purchase of another property?
Lenders that find out you plan on using the home equity loan to buy another property may want details on how you plan on using the other home, as well as what the costs will be. In rare circumstances, it’s possible that a lender with strict approval criteria could disqualify you from the loan if it determines you cannot afford the payment on both homes.
Otherwise, the process of getting a home equity loan is the same, and we’ve outlined the steps below.
Find a lender and submit a loan application
With home equity loans, it’s important to shop rates with multiple types of lenders such as credit unions, banks, and online lenders. Each has its pros and cons with regard to customer service hours, rates, fees, and types of loans offered. Shopping rates with multiple lenders will improve your chances of getting the best loan for your needs.
- Banks: Banks can have a wide range of loan types, but eligibility criteria tend to be strict and it can be difficult to get policy exceptions if you don’t meet the qualification requirements.
- Credit unions: Credit unions are not-for-profit organizations, so you can get more favorable rates and fees compared to banks. This type of lender also typically has a greater ability to issue policy exceptions if you have enough compensating factors in your loan application.
- Online lenders: Online lenders have few, if any, physical branch locations. With fewer overhead expenses, it can offer some of the best loan rates and pricing for home equity loans. However, some online lenders may have shorter customer service hours compared to banks and credit unions, and their rates are not always the most competitive.
Provide the lender with required documents
Once you’ve submitted a loan application, you’ll typically need to provide the lender with supporting documents. This typically covers aspects of your credit, income, and assets.
- Credit: Lenders will review your credit score and may ask for explanations for derogatory items on your credit report, or request loan statements detailing loan terms for your monthly debt obligations.
- Income: Standard documents can include pay stubs, W2s, and personal tax returns. If you’re self-employed and running your own business, you may also need to provide business tax returns and other financial statements like a balance sheet or profit and loss statement.
- Assets: If a lender requires reserves or proof of sufficient funds to cover closing costs, you may need to provide copies of a bank statement showing a large enough balance.
- Additional property information: This can include things like your homeowner’s insurance or homeowner’s association bill.
Lender orders appraisal and other third-party items
In addition to reviewing your own documents, lenders will also order a number of third-party services to verify other aspects of your property. This can include things like your home’s value, its condition, the legal owner of public record, and more. Below are some examples of items a lender might request from a third-party vendor:
- Appraisal: An appraisal will be required for most home equity loans, and is used to determine your property’s value and how much equity you have in the home. It can also be used to evaluate the condition of the property. Appraisals can be done with a computerized model, or require a physical inspection by a certified appraiser.
- Title report: A title report is completed by a title company to verify the legal owner. It will also reveal the property’s liens, including outstanding mortgages and unpaid tax liens.
- Tax certification: A tax certification can be conducted to verify the amount of property taxes due and whether your account is delinquent.
- Flood certification: Properties located in a flood zone will require additional flood insurance before most lenders will issue financing.
Loan approval is issued
Once a lender has obtained and reviewed the documentation above, it will issue a decision on the loan. There are typically five possible outcomes:
- Approval: The best outcome is that your loan is approved at the terms you have requested, with no additional documentation being required.
- Conditional approval: With conditional approval, lenders usually just need a few minor pieces of additional information. In most cases, it’s a good sign that you’ll get the loan terms you initially requested.
- Counter-offer: This can occur if the lender can issue financing, but just not at the terms you requested. They may issue a lower loan amount, a higher interest rate, or require you to pay off debt.
- Suspend: A loan can be suspended if a lender is missing critical pieces of information where there are multiple paths forward. If this occurs, lenders will ask you for clarification or additional information to determine what documentation it may require.
- Denial: A loan can be denied if a lender is not able to issue any type of financing. If this occurs, you’ll have a chance to discuss the decision with a loan specialist to determine how you might become eligible in the future.
Docs are signed
If your loan is approved, the next step is to sign the final loan documents with a notary. The purpose of meeting with a notary is to verify your identity. Lenders will schedule this for you, and you should expect a phone call from the notary to confirm the details of the appointment. Requirements can vary among different states, but most notaries will require one or two copies of a government-issued photo identification, such as a driver’s license or passport.
Home equity loan funds
Once you have signed the loan documents, they will be returned to the lender for review. This is done to ensure everything was signed properly. Once you get to this stage, it can take between one and three days for your loan to be funded. Funds can be disbursed to you as a lump-sum payment to your bank account.
What are some alternatives to a home equity loan for the purchase of another house?
If you’re not sure if a home equity loan is the best option to acquire another property, here are some alternatives to consider:
- Cash-out refinance: With a cash-out refinance, you’ll be replacing the terms of your existing mortgage loan. Your new loan will have a larger balance, some of which will be used to pay off the old loan. You can then use the remaining funds toward the purchase of another property.
- Retirement accounts: Some retirement accounts, particularly employer-sponsored accounts like a 401(k), allow you to withdraw funds for the purposes of purchasing real estate. Each plan is different, so you’ll need to review the terms of your plan to determine the specific eligibility criteria. For example, you may only be allowed to withdraw funds for the purchase of an owner-occupied property, but not an investment property.
- Investment accounts: If you don’t have a sufficient amount of funds in a checking or savings account, you can consider liquidating all or a portion of your investments. Investment accounts can include individual stocks, bonds, or mutual funds.
- Gift from family members: Many lenders allow for gift funds to be used as long as the home being purchased is not an investment property. In other words, it’s often allowed for a vacation home or a primary residence. Gifts must typically be from a family member, relative, or individual who has a familial relationship with you. This can include parents, a domestic partner, a godparent, or an individual engaged to marry one of the borrowers.
- Personal loans: A personal loan typically cannot be used towards the purchase of another home. However, guidelines vary from lender to lender. If you have exhausted all other options for funding, it’s worth asking a lender if it will allow the use of personal loans.
Should I use a home equity loan to buy another house?
Using a home equity loan to purchase another home can have a number of benefits. You can get more funding for a larger down payment, acquire a property that otherwise would not qualify for financing, and more. However, it also carries some risks such as potentially losing your home if you can’t afford the added monthly payments.
Before you make any final decisions, it’s important that you explore alternative financing options and understand the costs and risks involved with using a loan to buy another property.