Whether you are wanting to buy another home because you’ve outgrown where you are or because you are wanting to invest in real estate, tapping into your home’s equity can be very advantageous.
I’m going to go over how you can access the equity of your home to buy another property. In this article, I’ll also go over the pros and the cons of doing and some potential pitfalls that you need to be on the lookout for.
First and foremost, what is home equity?
Home equity is the difference between the current market value of a home and the outstanding balance on any mortgage or other liens against the property.
For example, if your home is worth $500,000 in today’s market and your current mortgage balance is $300,000, you would have $200,000 worth of equity.
Very simple.
Loans to access Your home equity to buy another property
When it comes to financing options to tapping into your equity to buy another property, there are three primary routes available.
Cash-out Refinance
This is a type of mortgage refinancing where you refinance your existing mortgage for an amount greater than the current outstanding balance.
Because you are taking a new, bigger loan, the difference between what you owe, and the new mortgage would be your “cash out”. The new loan would substitute your current one and it would have a new interest rate, terms, and payments.
For instance, if you have a mortgage for $150,000 and you did a cash out refinance for $200,000, your new mortgage loan would be for $200,000 and you would receive $50,000 as your cash out.
How does a cash out refinance work?
Uses of Funds: You can use the cash from the refinance for absolutely whatever you want. Most homeowner would use it for home renovations, debt consolidation, paying for education expenses, and of course, to buy another property to live in or invest in properties as investors.
Repayment: You now have a new, larger mortgage to repay.
Therefore, consider that before taking out the loan because odds are, your mortgage payment is going to increase.
You should probably think twice to take on a much higher payment if you get too big of a loan. Likewise, if you take a new 30-year mortgage and your intention is to make the minimum payment only, you will pay more in interest compared to your current mortgage.
To offset increasing your interest expense or having to restart paying on your home all over again, a cash out refinance allows you to adjust the repayment terms. With a refinance, you can take on a 20- or 15-year mortgage if your goal is to pay off your home faster.
At Andes Mortgage, our clients are able to choose the term they want and even “odd years”. For instance, we are able to offer 23 or 18 year mortgages.
Benefits: You get double the advantage on a cash out refinance when interest rates are lower than your current mortgage rate.
Since 2021, rates have climbed to levels not seen in 20 years. For many people looking to do a cash out refinance, this presents the opportunity to lower the rate as well.
On the other hand, one of the biggest disadvantages of a cash-out refinance is that if you have a low interest rate, this new loan will eliminate it as the mortgage would be paid off and replaced.
Many homeowners who took out a mortgage from 2020-2022 have rates that have never been seen – the all-time lows. Consult with a mortgage or financial advisor to see if makes sense to take a new mortgage loan at a higher rate but if you don’t want to do that, then the next two options avoid paying off your current mortgage completely.
Home Equity Line of Credit (HELOC)
Over the last 3 years, the popularity of the HELOC’s has exploded due to so many homeowners not wanting to touch their current first mortgage but, still, wanting to access home equity to buy other properties.
In short, a HELOC is a revolving line of credit that allows you to borrow against the equity in your home. This is a second mortgage, so it does not affect your current first mortgage.
How does a HELOC work?
Secured by your home: A HELOC is a 2nd lien on your home. The HELOC uses your home as collateral
The amount you can borrow is based on the equity in the home, and that would now include your current mortgage and what the house is worth. I’ll explain on the next section what Loan to Value and Combined Loan To Value means.
Revolving Line of Credit: A HELOC works similarly to a credit card. If you’ve had a credit card, then you know how a HELOC works.
The same way with a credit card, you have a limit, and you can draw as much as you need from that limit. For example, if you have a HELOC limit of $100,000, and you need $50,000 to tap your equity to buy another home, then you only pay based on that balance.
Don’t have a need to use it, and you want to keep the balance at zero?
No problem, if you don’t have a balance, you pay any interest or have any payments.
With a HELOC, you have what’s called as a “Draw Period”, typically 3-10 years to use it anytime you want, as much as you want. Normally, HELOC repayment terms are for 20 to 30 years.
Variable Interest Rate: The majority of HELOCs have variable interest rates tied to a benchmark rate, such as the prime rate. Your rate will change once a month and when the Federal Reserve adjusts the Fed Funds Rate.
From 2021 to 2024, the Federal Reserve aggressively raised interest rates to combat inflation. For those who have a HELOC, their rates went up as well.
Hopefully in 2025 and beyond, we can get some rate cuts, but you should always consider the worst case scenario.
Flexibility: One of the main advantages of a HELOC is its flexibility.
Borrowers can use the funds for various purposes, such as home improvements, debt consolidation, or use it to buy another home and especially, for those wanting to invest in real estate.
Many of our real estate investor clients use HELOCs to finance flips and for home renovations.
Biggest Potential Risks: You need to be a financially disciplined person before taking on a HELOC.
Many people get enamored by the fact that they now have access to tens and even hundreds of thousands of dollars and do whatever they want with it. We’ve seen many people close on a HELOC and instantaneously start to book flights to Europe, use it for a down payment on a luxury vehicle, and shopping.
Everything but use it as a tool to build wealth or fix their finances!
It is extremely easy to run up a $100,000 balance on a HELOC and then you’ll be stuck making that payment.
When you take on a HELOC, you may also be able to tap into more equity than a normal cash out refinance. In fact, there are lenders who allow a 95% combined loan to value HELOC, which means, you would be able to access nearly all the equity in your home!
If there is a downturn or correction in the real estate market and your home drops in value, you would be finding yourself upside down.
Home Equity Loan (HELOAN)
If a HELOC is equivalent to a credit card, then the HELOAN is equivalent to a personal loan.
A HELOAN is also a second mortgage nd provides you with a lump sum of cash that is repaid over a fixed period, with regular payments.
Therefore, unlike a HELOC which has variable interest and variable payments, a HELOAN is fixed.
Most HELOAN lenders will allow you to go up to 85% combined loan to value.
There’s not much to this, if you feel more comfortable having a fixed payment and you have a number in mind that you need tap to buy another home, then a HELOAN may be a good option for you.
How much home equity can you use to buy another property
There are two terms that lenders use and you need to know them especially if you want to use your home equity to buy properties.
Loan-to-Value (LTV): The LTV calculates the percentage of equity in a home.
Example: You have an outstanding balance of $150,000 and the value of the home is $300,000. The LTV would be 50% (150,000 / 300,0000) x 100.
Combined-Loan-to-Value (CLTV): The CLTV does the same thing as the LTV except, it now adds a second lien.
Example: You have a first mortgage balance of $150,000, you have a second mortgage or HELOC for $50,000 and the value of your home is $300,000.
The CLTV would be 67% ((150,000 + 50,000)/300,000)) x 100.
Lenders will not let you borrow against 100% of your equity.
Instead, they use a measurement called the “combined loan-to-value ratio (CLTV)” to determine how much of your equity you can access.
Most lenders will allow you to borrow anywhere from up to 80-90% of your home’s value after factoring in your existing mortgage balance.
This means if your home is worth $400,000 and your lender allows a CLTV of 85%, you could borrow up to $340,000 in total loans. Since you still owe $250,000 on your mortgage, that leaves you with $90,000 in accessible equity ($340,000 – $250,000 = $90,000).
You should also understand that even though you may have a large amount of equity, lenders will also calculate your debt-to-income ratio to gauge how much HELOC or HELOAN they can offer you.
In Conclusion
Whether you are thinking of using your equity to buy another house to live in or to invest in real estate, it is one of the most cost-efficient strategies to borrow money.
The home is often times is the largest nest egg for most people. Additionally, real estate loans give you the opportunity to leverage your home at much lower rates than any other type of financing.
At Andes Mortgage, we are specialists in all of these financing options that we talked about in this article. We help our clients with cash out refinances for primary, second, investment homes as well as home equity lines of credits and home equity loans.
If you are looking for one of these solutions or, simply, want to get some guidance into what may be the best thing for you, you may schedule a call with us by clicking this link below or call us at 770-740-4050.
