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, according to the data and analytics firm Black Knight.1
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.
The two most common ways to take advantage of your home equity is to use a home equity loan or a home equity line of credit (HELOC). But before you pull equity out of your home, ensure that you understand the risks and rewards of each.
Home equity loan (also called a second mortgage) allows 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, a home equity loan works 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.
Taking out a second mortgage comes with a lot of risks that can vary depending on what you end up using that money for. We discuss the pros and cons of using a home equity loan for different purposes below:
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.
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.
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.”
The 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.
1. Calculate your available equity: Use a HELOC calculator to determine the home equity you have in your home. Will this amount be enough to cover your planned expenses? If not, you’ll likely need to look into other modes of financing.
2. Prepare your application: Gather necessary documentation, like credit and bank statements, mortgage records, and proof of income. You’ll need these for your application.
3. Shop for the best HELOC lenders and apply: Go to multiple HELOC lenders and review their rates, terms, and conditions. Remember to read the fine print — how long is the advertised interest rate locked in? Will you be able to afford your payments if your rates go up? Once you find a lender with the best offer for your needs, apply.
4. Review your disclosure documents: Once you receive all of the documents, review them once more to ensure that the HELOC fits your needs.
5. Close on the loan: If the loan's terms and conditions work for you, sign and close. You’ll go through an underwriting process but it’s less rigorous than the mortgage underwriting process.
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, like Orchard. When you work with us, we’ll guarantee the sale of your current home and turn your home equity into cash that you can put towards the purchase of your next home without the hassle or stress of taking out a second mortgage or line of credit.
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