How to use a home equity loan to buy another house

A home equity loan¹ can provide homeowners with cash they can use to buy another home. It allows you to borrow equity from your primary residence in a lump sum and at low interest rates that you can use to make a down payment or cover closing costs on an investment property or vacation home.

Learn more about how to use a home equity loan to buy a second home, the pros and cons of this strategy, and alternative options.

Key takeaways:

• A home equity loan allows you to borrow the equity you’ve built in your current home as a lump sum of cash.
• You can use these funds to make a down payment on a new home or investment property, or to make your purchase offer more competitive.
• Using this strategy means taking on additional debt because your current home serves as collateral.

What is a home equity loan?

Home equity is the difference between your home’s fair market value and what you owe on the mortgage. For example, if your home is worth $350,000 and your mortgage principal balance is $200,000, you have $150,000 in equity.

A home equity loan is a second mortgage that uses your home equity as collateral to borrow money. You receive a lump sum and make payments over a set term, usually at a fixed interest rate.

One of the ways you can use a home equity loan is to make a down payment on another property.

Your home is collateral on the second mortgage, so you risk foreclosure if you default on the payments.

How to use a home equity loan to buy another house

If you’ve built up a substantial amount of equity in your primary residence and want to use it to buy another property, here’s how to get started.

Calculate your home equity

First, you’ll need to estimate how much equity you have. You can do this by subtracting your current mortgage balance from your home's estimated current market value. You also can use the home equity calculator from Rocket Mortgage.

Keep in mind that a home appraisal will be required to determine exactly how much equity you have.

Estimate how much you may be able to borrow

Lenders typically allow you to borrow up to 75% to 85% of your home’s appraised value minus your existing mortgage balance.

Based on the example above, 80% of a $350,000 home is $280,000. Subtract your $200,000 mortgage balance, and you may be able to borrow up to $80,000.

Compare terms and requirements

You need to meet your lender’s requirements to qualify for a home equity loan. Exact eligibility criteria vary, but you’ll typically need:

• A minimum credit score of 680
• A debt-to-income ratio (DTI) of 43% or less
• Proof of income
• At least 15% - 20% equity
• Proof of homeowners insurance
• Solid payment history on your primary mortgage
• A home appraisal

DTI measures how much of your gross monthly income goes toward paying debts. Adding a home equity loan will increase this ratio, so you must prove you can comfortably handle the new payment.

It's wise to get a Loan Estimate from several lenders so you can compare offers and choose the one with the best terms.

Apply and use the funds for the new property

Once you’ve chosen a lender and confirmed that you meet their eligibility requirements, it’s time to apply. You’ll need to provide financial documents during the mortgage underwriting process to show that you can afford to repay the loan.

Once approved, you will receive your home equity funds as a lump sum. You can then use the funds to make a down payment or to cover closing costs on a new property.

Advantages of using a home equity loan to buy another house

Using a home equity loan can be a convenient way to borrow money at low interest rates compared with personal loans or credit cards. Here are the primary reasons borrowers consider this strategy.

You can access a lump sum

Because you receive the funds as a single lump sum, you get the immediate liquidity you need to make a down payment or cover closing costs.

You may make a larger down payment

Tapping into your equity also allows you to make a substantially larger down payment on the new property. A bigger down payment can help you get a lower mortgage interest rate and reduce your monthly payment. Making a larger down payment also reduces your principal balance and allows you to make a more competitive offer.

You may avoid PMI

A down payment of at least 20% on a conventional loan allows you to avoid paying for private mortgage insurance (PMI), which can save you hundreds of dollars every month.

You can keep your current mortgage in place

If you locked in a low mortgage rate for your primary residence, a home equity loan allows you to leave that first mortgage completely untouched. You borrow the equity via a second loan without having to refinance the first.²

Disadvantages of using a home equity loan to buy another house

Despite the benefits of using a home equity loan to buy an investment property, there are downsides.

Your current home is on the line

The most significant disadvantage is that your current home is collateral for the home equity loan. That means that you risk losing it to foreclosure if you default on the payments.

Your DTI may increase

When you take out a home equity loan, you take on new debt. Your DTI may increase significantly. Lenders will calculate this new ratio, and you will need to prove you have the income to comfortably manage the payments on both properties. A high DTI can make it harder to qualify for the actual mortgage on the new home.

You have multiple mortgage payments

If you keep your current home and finance a new one, you could be responsible for three separate payments: the first mortgage on your primary residence, the home equity loan, and the mortgage on the new property. Balancing these multiple mortgage payments requires a reliable, stable income.

Your tax deduction may be limited

The interest on home equity debt is tax-deductible if the funds are used to buy, build, or substantially improve the home that is acting as collateral. Using the funds to buy a different house means you generally lose this tax break. Deductibility and other tax implications can vary widely based on your specific situation, so readers should consult an experienced accountant before making decisions.

Home equity loan vs. HELOC vs. cash-out refinance

A home equity loan, home equity line of credit (HELOC), and cash-out refinance are all ways you can use the equity you’ve built in your home to borrow money. However, each option works differently and comes with a different set of trade-offs. Let’s take a look at some of the key differences to help you decide which best fits your needs, goals, and financial situation.

HELOC

Like a home equity loan, a HELOC is a second mortgage that uses your home as collateral. However, instead of getting the money as a lump sum, you have access to a line of credit that you can draw on as needed for a specific time. Another key difference is that home equity loans typically have a fixed interest rate, while HELOCs come with an adjustable rate. Using a HELOC to make a down payment can make sense if you also want to use your credit line for other expenses.

Rocket Mortgage does not currently offer HELOCs.

Cash-out refinance

Unlike a home equity loan and a HELOC, a cash-out refinance is not a second mortgage. Instead, it’s a new primary mortgage based on your home’s current fair market value. After you pay off your current mortgage, you keep the leftover cash and repay it as part of your new loan.

This is another way to access equity while consolidating your debt into one single payment, but it replaces your current interest rate. A cash-out refinance can be especially beneficial if interest rates have dropped since you took out your primary mortgage. However, you’ll need to pay closing costs.

Using home equity for different types of properties

The way you use your equity to buy a home can differ depending on the specific property use you have planned:

• Buying a second home. If you are using home equity to buy a second home for personal use, such as a vacation home, using equity from your primary residence can easily fund the down payment. Lenders will evaluate whether you can afford the payments on both your primary residence and your second home.
• Buying an investment property. Using a home equity loan for investment property purchases is common. The loan can help you come up with the steeper down payment that’s required on an investment property, which is often at least 25%. This allows you to expand your real estate portfolio without liquidating other assets.
• Buying another house while keeping or renting your current home. If you want to buy a new primary residence without selling your first home, equity financing can be useful. However, you’ll need to confirm you can take on the added debt of the new primary mortgage while still carrying the debt of your first home.

Alternatives to using a home equity loan to buy a second home

If a home equity loan, HELOC, or cash-out refinance isn't right for you, there are other financing options available to help you buy another property.

• Hard money loans. These are high-interest loans typically secured by property and funded by private investors and companies. They usually have shorter terms and higher interest rates.
• Seller financing. The seller takes the place of a lender and finances the purchase themselves. You repay the seller in installments until the loan is paid in full. Seller financing generally offers more flexible loan terms but comes with higher interest rates and larger down payment requirements.
• Peer-to-peer lending. P2P loans are personal loans, and no collateral is required to secure them. The loans are funded by individuals or groups of investors instead of traditional financial institutions. You may get a lower interest rate and more flexible terms if you have excellent credit. You may not be able to borrow as much as you can from a mortgage lender.

FAQ

Here are answers to common questions about using a home equity loan to buy another home.

Is it worth using equity to buy another property?

Yes, if you have enough stable, reliable income to support the new debt and a clear strategy for the second property. But a home equity loan also increases your debt load and puts your primary residence at risk if you default. Be sure to determine if a home equity loan is a good idea for your specific circumstances.

When can I sell my house after taking out a home equity loan?

You can sell at any time. There’s no set time limit to sell your house after taking out a home equity loan. However, you must pay off all liens on the home before you can close the sale. This includes your home equity loan, because your home acts as collateral for the loan.

Will a home equity loan put my mortgage underwater?

An underwater mortgage happens when a home loan's principal balance exceeds the home's appraised value. This scenario typically occurs when a property's value falls as a homeowner repays their mortgage. A home equity loan by itself usually won't cause an underwater mortgage, but if you borrow too aggressively, it can contribute to being underwater.

The bottom line: You can use your home equity to buy another house

You can use your home equity to buy a second home or investment property. A home equity loan can provide the lump sum needed to fund a heavy down payment without having to wait to save up enough and avoid costly PMI. However, borrowers should carefully compare upfront costs, consider alternatives, and understand the risk to their current home before applying. By carefully preparing your finances and understanding the terms, you can safely navigate the process and achieve your real estate goals.

If you’re ready to apply for a Home Equity Loan or explore your borrowing options, get started today with Rocket Mortgage.

¹Home Equity Loan Product is a second standalone lien and may not be used for piggyback transactions. Valid for loan amounts between $45,000.00 and $500,000.00 (minimum loan amount for properties located in Michigan is $10,000.00). Not available on Ameriprise products. Additional restrictions, terms, and conditions apply. Must meet qualification requirements. This is not a commitment to lend.

²Refinancing may increase finance charges over the life of the loan.