When planning to buy a second home, you often need to find additional ways to fund your purchase. This is where using your home equity can come in handy. Using home equity to buy a second home comes with many advantages: it gives you access to funds that you may not have on hand, and it’s a trusted source of funding from lenders (provided, of course, that you have the credit and income to support it).
But what exactly is home equity and how do you do use home equity to buy another property? This simple guide will help you on tapping this resource.
What is home equity?
For those who might not be familiar with the term, home equity is your share in the total value of your home, or your actual stake in the property. For instance, if you used your own money to pay the 20% down payment for your current home then get a loan to complete the payment, your home equity will be the 20% down. When you pay off your loan, the amount you pay is carried over to your home equity, making it grow.
Through a cash re-finance, a home equity loan allows you to borrow the equity from your primary residence. To put it simply, a home equity
loan involves taking out a new loan on your primary residence which includes the balance originally owed plus the equity that you have.
Lenders are favorable to this type of loan, particularly because the first home acts as a sort of collateral. More often than not, most homeowners will be more diligent with paying off their loans, as defaulting would mean losing one of their residences.
Home equity can be used for a variety of purposes. For instance, if you are doing major repairs on your house, you can use it to cover the cost. It is also normal for people to use their home equity as a means to finance their children’s education. In fact, home equity be used to finance the purchase of a second house.
Using home equity to purchase a second home is also more advantageous than taking money out of your IRA’s or 401(K)’s. This is because the latter options come with heavy taxes and penalties to discourage you from using your retirement funds.
Why use it?
One of the biggest reasons why you might want to tap into your home equity is because it serves as an easy source of funds. Think of it as a sort of savings account you can use anytime you need. Provincial Bank explains that lenders actually give more favorable terms to people who use their home equity in Lakeville for a second mortgage.
Another great thing about using home equity to purchase a second home is that the interest paid is tax deductible, just like a regular mortgage. Because you’re using it to purchase a second home for your personal use, the usual $100,000 home equity debt cap is lifted. This means that you can deduct the interest paid on both your primary and secondary residences for up to $1 million in mortgage debt. Most lenders will allow borrowers with good credit to loan up to 85% of the value of their current home, with any other mortgage secured by that property being deducted from the amount being borrowed.
But keep in mind that there are you also have to deal with certain risks. With your home equity being used, you increase the risk of your first home being foreclosed. In addition, you are tying your finances to only one type of asset, which may reflect badly on your financial history. Using a home equity loan to buy another property also requires a significant amount of equity in your primary home.
How to use your equity effectively
When tapping into your home equity, you should carefully choose how to use it to fund your purchase. For instance, you might be attracted to going for home equity loans because of low rates. However, you should remember that these rates would eventually go up.
Also, remember only to tap into your home equity as a last resort. If you can find a better means of financing your new mortgage, stick to it instead. However, when out of options, you may give it a go.
Before using a home equity loan to buy a second house, always consult with a certified accountant or talk to a trusted lender. They can perform a comprehensive review of your finances and determine whether or not a home equity loan would be the best option for you.