Can You Use Home Equity To Buy an Investment Property?
Using home equity to buy an investment property is possible, but like any major financial decision, there are both benefits and risks to consider. Whether you’re looking to make passive income, grow your real estate portfolio or buy a vacation home, here’s what to know about using equity to buy another home.
- You can use a home equity loan or home equity line of credit (HELOC) to tap home equity for real estate investments — both loan types are common options.
- Using equity to buy a house may make sense if you have limited cash savings.
- Requirements vary by lender, but you’ll generally need a solid credit score and sufficient equity to qualify for financing.
What is home equity?
Home equity is the difference between your home’s value and what you owe on your mortgage. That means if your home is worth $400,000 and you owe $300,000 on the mortgage, you have $100,000 in home equity ($400,000 – $300,000).
You can tap your equity without selling your home by getting a home equity loan or home equity line of credit (HELOC). These are often called “second mortgages” because they’re typically taken out in addition to your first mortgage. Sticking with the example above, you can borrow a portion of your $100,000 equity to put toward the purchase of an investment property or second home.
Another option for buying an investment property with equity is through a cash-out refinance. This involves replacing your current mortgage with a bigger loan and “cashing out” the difference to use for any purpose — including another home purchase.
Home equity loans and HELOCs both allow you to tap your home equity but work in different ways. With a home equity loan, you receive a lump-sum payment that you pay off in monthly installments over a set term.
A HELOC, on the other hand, is a credit line you can withdraw funds from as needed — similar to a credit card. One key difference is that home equity loans generally have fixed interest rates, while HELOC rates are variable.
Learn more about how to choose between a home equity loan and a HELOC.
How to use equity to buy another house
1. Calculate your home equity.
The first thing you want to figure out is how much equity you have to work with. Once you know the equity you have in your home, you’ll have a better idea of the amount you could put toward buying a new property. To determine your home equity, use this simple formula:
Home value – Mortgage balance = Home equity
Find out how much you could borrow using our home equity loan and HELOC calculator.
2. Assess your finances.
You’ll want to take an honest look at your finances to see where things stand in terms of your credit score, income and debts. You can check your Equifax, Experian and TransUnion credit reports for free on AnnualCreditReport.com. If your credit score has dropped since getting your first mortgage, it may make sense to address the factors impacting your credit before applying for a second mortgage.
Don’t know your credit score? Get your free score on LendingTree Spring today.
3. Explore financing options and submit an application.
It’s a good idea to compare the different options available, including home equity loans and HELOCs, and understand the rates, repayment terms and costs associated with each option. Rates and requirements can vary by lender, so it’s wise to shop around before making a decision. You’ll generally need to show that you have solid credit, manageable debt payments and stable income on your loan application.
Should you use home equity to buy an investment property?
Using the equity in your home to purchase an investment property can be a good option, but it’s not a one-size-fits-all solution. Here are a few reasons someone may choose this path:
- You don’t want to drain your savings. Tapping into your home equity allows you to invest in another property while keeping your savings intact. This can be particularly important if you know you’ll need cash for home repairs.
- Your returns would outweigh the costs. If the investment property will generate enough returns to offset the costs of borrowing, including the closing costs, then it could be a good idea to invest.
- You want to jump on an investment opportunity. HELOCs tend to have fast approval times, making it easier to jump on time-sensitive investment opportunities.
Learn about more ways to use your home equity.
Pros and cons of using home equity to buy an investment property
Pros
- You’ll have access to capital: Using your home equity gives you access to funds without depleting your savings account or selling other assets.
- You could make a larger down payment: If using some of your equity can help you make a bigger down payment, you could end up with better loan terms on your investment property loan.
- You may get a lower rate: Home equity loans and HELOCs generally have lower interest rates than personal loans or hard money loans.
Cons
- You’ll have multiple mortgage payments: You’ll be responsible for three different mortgage payments — 1. Your current mortgage, 2. The home equity loan or HELOC payment and 3. The mortgage on the investment property.
- Your home value could drop. With real estate, there’s always a risk that home values could fall and cause you to become underwater on your mortgage.
- You’re turning an asset into debt: When you use home equity to buy another house, you’re essentially converting an asset (the home equity) into debt and putting your home at risk of foreclosure if you default on the loan.
Lenders will typically look for the following criteria when deciding whether to qualify you for a home equity loan or HELOC:
- A minimum 620 credit score
- A maximum 43% debt-to-income (DTI) ratio
- A maximum 85% loan-to-value (LTV) ratio
- Sufficient income
Learn more about the home equity loan requirements you’ll need to meet before applying for one.
Compare home equity loan rates from top lenders in minutes
Alternatives to buying an investment property with equity
If you want to leave your home equity alone but still want to buy an investment property, some other options include:
- Hard money loan. Hard money loans are short-term, high-interest loans that are typically secured by the property you’re financing. Private companies and investors offer these types of loans, which usually must be repaid within six to 24 months.
- Peer-to-peer (P2P) loan. P2P loans are funded by individuals or groups of investors and, unlike some of the other options available, they typically don’t require collateral.
- Personal loan. A personal loan is another option to get your hands on some cash, but keep in mind the interest rate will typically be higher than rates on home equity loans or HELOCs.
- Seller financing. With a seller financing arrangement, the home seller — not the mortgage lender — provides funding to the homebuyer to buy a property.
Frequently asked questions
It’s possible to take out a home equity loan on an investment property, but it may be more challenging than getting one on your primary residence. You’ll typically need a strong financial history and sufficient equity in the investment property to qualify.
Yes, you can pay off a HELOC early — and doing so can help you save on interest and lower your monthly payments. Many real estate investors use this strategy after completing a fix-and-flip project, using the sale proceeds to pay off what they owe. One caveat: Check your loan agreement — some lenders charge a prepayment penalty for repaying a HELOC early.
Whether you should use a home equity loan or a HELOC depends on your financial needs and how you plan to use the funds. A home equity loan may make sense if you want a chunk of money upfront and fixed, predictable monthly payments. If you want ongoing access to funds for multiple purchases or repairs, a HELOC is likely a better fit. Both options involve taking on an additional payment and using your home as collateral.
Compare Home Equity Offers
Read more
How To Get the Fastest HELOC Closing Times Updated June 28, 2024 The fastest HELOC lenders can get you a home equity line of credit in 5…Read more
How To Get a High-LTV Home Equity Loan or HELOC Updated May 13, 2024 Don’t let HELOC LTV limits get you down — it’s possible to borrow up to…Read more