A guide to using home equity to buy a new house

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Most Americans’ greatest asset is their home. Homeowners who have built up their equity may want to tap into that asset, especially when buying a new house. But is it possible to use home equity to purchase a new home? While the short answer is yes, the longer answer is that it’s not as simple as you might want it to be.

This guide answers everything you need to know about using the equity in your current house to buy another home.

How to use home equity to purchase a new home

According to the data and analytics firm Black Knight, the average American home has appreciated almost 9% in value since 2022, helping homeowners gain $2.8 trillion in tappable equity since June 2021. That breaks down to an average of more than $207,000 of equity per mortgage holder. 

Tappable equity refers to the amount of equity available to mortgage holders to borrow against while maintaining at least a 20% equity stake in their homes, as required by most lenders. This is significant for homeowners looking to capitalize on that money without the added burden of private mortgage insurance.

The two most common ways to take advantage your house as an asset is to take out a home equity loan or a home equity line of credit (HELOC).

Using a home equity loan to buy another house

Home equity loans allow homeowners to borrow against the equity in their current home, with the loan amount based on the difference between the home’s current market value and the mortgage balance due. Like the name “second mortgage” suggests, home equity loans work much like a typical mortgage with a set repayment term and fixed payments that cover both the principal and interest.

Home equity loans are different from a refinance in that they don’t replace your previous mortgage with a new one — these are an additional loan on top of your existing mortgage.

Using home equity to purchase a second home or investment property

It may be tempting to turn all of that untapped capital into a vacation home or investment property. While the advantages of using a home equity loan might seem overwhelming, it’s important to weigh both the pros and cons before following through on that transaction.

Pros

  • Lower interest rates: Home equity loans generally have lower interest rates than other types of financing because your primary residence serves as collateral for the loan.
  • Larger down payment: The cash you receive from your home equity loan can help you put down a larger down payment or turn you into a cash buyer and make your offer stand out in a competitive market. 
  • Easy to qualify: Getting a mortgage for a second property can be difficult, and home equity loans are generally easier to secure.

Cons

  • Exchanging assets for debt: The equity in your home is an asset; you own it outright. But when you take out a home equity loan, you use that asset as collateral, turning it into debt. This can have a negative impact on your debt-to-income ratio, which compounds if you take out an additional mortgage on your second property.
  • Three mortgages for two homes: Home equity loans are called a second mortgage for a reason — they come at the cost of a lien against your home. If you buy an investment property, you could end up paying three mortgage payments a month for only two properties.
  • Interest not tax-deductible: Unless you take out your home equity loan to improve your investment property, the interest you pay on it will likely not be tax-deductible like your mortgage interest payments are.

Using home equity to buy another house of primary residence

Maybe it’s time to downsize, expand, or you’re moving across the country. Whatever your reasons are, you want to buy a new primary residence. Using the equity in your current home could be a way to make that decision easier, but there are some pros and cons to consider before tapping into that asset.

Pros

  • Become an all-cash buyer: It’s no secret that cash offers are the way to stand out in competitive markets. If you’ve built enough equity in your current home, you may be able to take out a loan to make a cash offer on your next home.
  • Lower interest rates and fewer fees than alternatives: Home equity loans generally have better rates and terms than other types of loans, like a bridge loan or personal loan, which can keep your costs lower in the long run.

Cons

  • You cannot take out a loan after your house is on the market: This option will require some foresight. You will not be eligible for a home equity loan if you apply while your current house is on the market.
  • You could face foreclosure: You’ve taken out a home equity loan to serve as the down payment on a new house with a new mortgage. In a worst case scenario, you’re unable to sell your previous home to pay off your previous mortgage and your home equity loan, so now you’re stuck with three mortgages and a house that won’t sell. If you’re unable to make the payments on your home equity loan or mortgage, the bank could foreclose on your house.
  • You have to pay closing costs: Home equity loans have closing costs of 2% to 5%. You may prefer to sell your existing home first to unlock your equity and avoid having to pay these fees in addition to any interest from your loan.

Using a HELOC to buy another house

A home equity line of credit, or HELOC, is another option for unlocking some of the latent power of home equity. HELOCs offer homeowners the ability to turn their equity into a line of credit that they can access within a given timeframe called a “draw period.”

This flexibility is beneficial for homeowners who are house flipping or fixing their house up before selling it because it allows them to pay for costs upfront, then repay those costs once the property has sold. It can also be advantageous to homeowners who aren’t sure how much equity they need, as it allows them to only pay interest against what they spend rather than the whole sum they’re eligible to borrow.

However, interest rates for HELOCs are generally variable, so your payments could dramatically change month to month. Be prepared to face fluctuating payments if you use a HELOC to buy another house.

How power buyers unlock your home equity

Homeowners who want to move but aren’t sure how to use their home equity to purchase a new house might consider working with a power buyer. These companies are focused on empowering homebuyers by offering them a variety of services to stand out in a competitive market.

If you’re looking to use your home equity to buy a new home, Orchard can help. We can guarantee the sale of your current home, and turn your home equity into the liquid money you need to become a cash buyer.

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