If you have equity in your current home, you may have quite an investment there. What if you want to further your investment in real estate, though? Can you use the equity in your home to buy another home?
The answer might be ‘yes.’ It depends on your circumstances. Using your home equity is actually one of the best ways to start investing in real estate because of the low-interest rates and ability to earn a decent return on your investment.
The Advantages of Using Home Equity to Buy Another Home
Using your equity to buy another home has many advantages including:
- You don’t need cash down payment – If you don’t have cash saved up because you invest in your current home or you put your extra money away for retirement, you may think you’ll never own another home. Using your home’s equity, you can put down a sizeable down payment and purchase that additional home.
- The costs are generally low – Lenders typically have to do less work on a home equity loan or line of credit. This often translates into lower closing costs for you. If you were to apply for a first mortgage on the new property, you’d likely pay as much as 5% of the loan amount in closing costs.
- The interest rates are generally low – You can typically secure a lower interest rate on a home equity loan than a loan on a second home. That’s because loaning money for a second home is risky. If you reach financial distress, chances are that you will stop paying the mortgage on your second home, letting it go into default. That’s why mortgages on second homes typically have higher interest rates than the rates on a home equity loan.
- You don’t have to lose the ability to invest elsewhere – If you didn’t use your home equity, you might have to make the decision to stop investing in other areas, such as your retirement plan. This can have a negative effect on your financial future. You don’t have to worry about this opportunity cost when you use your home’s equity.
The Disadvantages of Using Home Equity to Buy Another Home
As with most things in life, there are some downsides that you should consider before using your home’s equity to buy another home:
- Your investment is illiquid – Once you invest your home equity in a second home, it’s tied up until you start paying the loan balance down. This means you don’t have that ‘emergency fund’ should something occur that requires more funds than you have on hand.
- You can’t deduct the mortgage interest – The new tax laws prohibit borrowers from writing off the interest on their home equity loan if the funds are used for anything except to benefit the home that it’s tied to. In other words, you don’t get the benefit of a tax write-off when you use your equity to buy a different home.
- You could end up underwater – There’s no saying what the real estate market is going to do moving forward. The hope is that the housing crisis never happens again, but no one knows what will happen for sure. If values deplete, you could get upside down on your current mortgage as well as the mortgage on your second home.
If you have the equity in your primary home and you are financially secure in other areas of your life, using your home’s equity to invest in real estate can be a lucrative choice. You stand the chance to make serious gains as well as earn cash flow if you rent the property to others. As always, make sure you weigh the pros and cons as they pertain to your situation though to make sure that it makes financial sense for you.