Table of Contents
- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
Guide to Buy Second Home Using Home Equity
If you have a favorite vacation destination that you often visit it might make sense for you to buy second home (vacation home).
However, buying a vacation home is not at all the same as booking a hotel room on each trip. It will be a very long-term expense which you will have to figure out how to pay for. One thing you can do is tap into the home equity
if you have enough equity in your home and use it to buy second home.
Although this way you can minimize the amount of money you pay out of pocket, it is important to consider every detail and make an informed decision on whether doing this makes good financial sense to you or no.
How this works
You can tap into and use your home equity in 3 different ways:
- Home equity loans
- Home equity line of credit
- Cash-out refinance
All three of these options can help you access your home equity and free up cash to buy a vacation home.
However, each one will have a different effect on your finances. For example, a HELOC is a line of credit from which you can draw cash as and when you need it and is thus flexible.
One advantage of Home Equity Line of Credit is that you will have a low monthly payment, or you will have to make only interest-only payments.
However, HELOCs usually have variable interest rates and an increase in the interest rate can cause an increase in the interest you pay.
A home equity loan can help you get a lump sum amount that you can use to buy vacation home.
Much like in the case of a HELOC, you will have to make monthly payments here as well, but the interest rate is often fixed.
A cash-out refinance is quite different in the way it works. In a cash-out refinance the borrower pays off the old mortgage loan using a new mortgage and gets to draw the accumulated equity in cash.
This leaves you with only a single payment to deal with which is undoubtedly a positive.
Homeowners have some flexibility in terms of how their home equity can be used for buying a vacation home.
A second home generally requires a 10% to 20% down payment and thus depending on how much home equity you have, you can either buy the home or just use the equity you accumulated in your primary home for making the down payment.
Should you Buy Second Home using your Home Equity?
Whether or not you should use your home equity for buying a second home depends on a number of factors including the method you choose to tap into the equity and the terms of your current mortgage.
For example, you may want to avoid refinancing all together, if the mortgage you currently have has favorable terms.
However, if the current interest rates are lower compared to the rate of your current mortgage, it may be beneficial to refinance by tapping into your home equity.
The amount of equity you have accumulated in your home also matters as it helps you determine which refinance option you will be eligible for.
For example, in the case of HELOC, the amount of equity you have in your home plays a very important role.
This is due to the fact that your lender considers your home equity to calculate the loan-to-value ratio, which is an important factor in deciding whether the lender approves your application or no.
Things to consider
Before you can tap into your home equity to buy a vacation home, you need to think carefully about:
- How much home equity you are willing to use?
- How much home equity will you need to buy the home?
- How does a HELOC, home equity loan, or cash-out refinance payment fit your budget?
- The qualifications you will need to tap into your home equity.
Lenders usually also perform a credit check when you apply for a home equity loan, HELOC, or a cash-out refinance.
If you have a good credit score of 700 or above, you may quite easily get approved. However, you may find getting approved difficult if you have a credit score of 620 or even less.
It is also important to remember that your credit score affects the interest rate as well and a better credit score will get you a lower interest rate.
Apart from your loan-to-value ratio and credit scores, lenders also take into consideration your debt-to-income ratio.
Another important factor you must consider before buying a vacation home is the effect it will have on your finances.
Buying a vacation home will not only result in two mortgage payments for you to manage, but it will also result in additional costs like homeowner’s insurance, property taxes, and maintenance for the vacation home.
If you have any doubts, be sure to talk to your lender and discuss every available option and whether it is wise to use your home equity to buy a vacation home.
