Is it possible to use a home equity loan to buy a second home? The hard and fast answer is yes, but this shouldn’t be a rushed decision. Find out the intricacies and details about using home equity to buy a second property, either as a second home or as an investment property.
Let’s get into it!
What is home equity?
Home equity is a monetary sum that you own in your home, as opposed to a mortgage balance that you still need to pay off. You can work out how much home equity you have by subtracting your existing mortgage balance away from the current value of your home. Do not use the amount you purchased your home for as this may no longer reflect its current value.
Home equity is easily understood with a simple example. If you own a property worth £300,000 and you have £100,000 left to pay on a mortgage, you therefore have £200,000 equity in your property.
What is a home equity loan?
A home equity loan is a special type of loan that allows you to use your home equity as collateral within a loan agreement. You’ll generally be able to use as much as 80-85% of the equity in your home as collateral, which reflects the maximum amount of loan you can get. So, if you have £100,000 of property equity then you could get a loan worth up to £80,000-£85,000.
The loan to value ratio of 80-85% is set like this to protect the lender and the homeowner in the event the property value decreases. You should only apply for one of these loans through a lender that is authorised and regulated by the Financial Conduct Authority.
The pros and cons of home equity loans
Home equity loans have pros and cons and anyone considering using one of them for any reason should be aware of them. The pros and cons of home equity loans are:
- They have competitive interest rates due to the equity being used as collateral. Lenders feel more comfortable in this situation and as a result, can offer lower interest compared to unsecured options – but not always.
- They allow you to access large amounts of credit that may not be possible with alternative credit options, such as unsecured personal loans or a credit card.
- They are widely available through banks, online lenders and building societies. And you can apply for them easily online.
- You are risking your home when taking out any home equity loan.
- You may have to pay for an appraised valuation to help the lender calculate your current home equity accurately.
- You might be subject to closing fees at the end of the loan term. These fees can be as high as 5% of the value of the loan, meaning if you took out a large amount you will have to pay thousands extra. This may wipe out any savings made through a lower interest rate.
Can I use a home equity loan to pay off my current mortgage?
It is possible to use a home equity loan to pay off your current mortgage or even a proportion of it. This can be beneficial if the loan has a better interest rate than what your mortgage is charging you. However, you should consider any other applicable fees, such as loan closing costs and early mortgage repayment fees. It might not be an advantageous strategy for you.
Can I use the equity in my house to buy another house?
It is possible to use your home equity to buy another house. You may want to unlock your equity to contribute a lump sum towards a second home deposit, or you may have enough existing home equity to buy another property outright. Or you may even want to buy another property as an investment that will be rented out.
You can do this in theory, but you will still need to prove that you can repay the initial home equity loan, and then you will need to prove you can afford the second home mortgage while also declaring you have a home equity loan. It’s a solid option to buy a second house for some people, but you still need to be approved for all the credit required to make it happen.
How much equity can I use to buy a second home?
There is no fixed amount of equity you can utilise to help you in buying a second home. It will depend on your financial situation and proving you can meet the payments. However, the maximum amount of equity a lender will allow you to access is between 80% and 85%. So you will not be able to use more equity than this in most cases.
Buying a second home vs buying an investment property
The difference between buying a second property and buying a new property to generate rental income is usually clear cut. The former is buying a home you will use exclusively at different times of the year. For example, buying a house by the coast or in the Lake District for summer holidays with the family.
The latter is when you buy a second property that will be rented out to other people who pay to live there – or pay to holiday there. In this case, you’ll usually require a buy-to-let mortgage as opposed to a standard residential mortgage.
Advantages of using home equity to buy an investment property
The advantages of using a home equity loan to buy a second house as a rental investment are:
- Increase your second property deposit – the deposit on your second mortgage may need to be bigger than your first, especially if you require a buy-to-let mortgage. A home equity loan can provide you with a lump sum amount that increases your second house deposit and makes it all possible.
- Lower interest payments – home equity loans typically have some of the lowest interest rates on the credit market. By using a home equity loan instead of other options, you could save money on interest.
Disadvantages of using home equity to buy an investment property
Just like any source of credit, there are also downsides to using a home equity loan, such as:
- Increased equity at risk – everyone who becomes a homeowner exposes themselves to some risk that the housing market could topple against them and lose equity in a home that was once more valuable. If you buy a second property using equity, you increase the risk of dreaded negative equity.
- Debts are less streamlined – instead of having the same number of mortgages as homes, you will also have the home equity loan that is similar to a mortgage (but not the same!). Your debts are less streamlined and can be more tricky to manage.
- Closing costs – you’ll still be subject to closing fees and other potential costs.
Can I remortgage my house to buy another property?
Yes, it is possible to remortgage to buy a new property. You can remortgage your existing home to release equity – also known as a cash-out refinance – that can be used as a downpayment on the new property and a new mortgage.
Or you may be able to remortgage to buy the second property outright with no need for a second mortgage. This will only be possible if the equity you can access covers the full value of the second property (or you have savings to add to your equity and buy the second home outright).
You should be aware of increased stamp duty payments when you buy a second property.
How to remortgage to buy another property
To remortgage to buy a second property you need to swap your existing mortgage for a new one. The new mortgage will require you to borrow more than your existing mortgage so you can tap into your accumulated home equity.
For example, if you own a property worth £300,000 and have a £100,000 mortgage (£200,000 in home equity), you could remortgage for £200,000 instead of the £100,000 owed on the current mortgage. Remortgaging in this way would give you an additional £100,000 that could be used to help buy a second home, holiday home or rental investment. Although this is similar to using a home equity loan, it is not exactly the same and there are key differences.
To qualify to refinance and remortgage in this way the lender will need to evaluate your personal finances, not limited to your regular income, existing debts and your credit score. Only by generating a complete picture of your finances and crunching the numbers will a lender be able to know if they can help or not.
You should get expert advice and professional support to ensure you make the right decisions and choose the correct mortgage type for your needs.
Can I use a HELOC to buy a second house?
You can also use a home equity line of credit (HELOC) to buy another property. A HELOC is similar to a home equity loan with some key differences, namely:
- It provides you with a line of credit over the draw period of many years. Homeowners can access this credit as they wish, a bit like using credit cards.
- Many lenders provide HELOCs with a variable interest rate rather than fixed interest.
- Repayments only begin after the draw period ends, rather than immediately after the loan is taken out.
You can leverage home equity to access a large sum to be put towards a buy to let mortgage, standard mortgage or to purchase a property outright.
Can I utilise my home equity with a poor credit score?
It’s not impossible to get a home equity loan, HELOC or remortgage with a bad credit history, but it is made harder. Lenders prefer to lend to people with a track record of being able to repay their credit on time and in full.
You might still be offered a loan or new mortgage, but you may have to pay more interest than those with a good credit score. Search the market to discover all your options.
Using a reverse mortgage to buy property
A reverse mortgage is the opposite of a standard mortgage. Instead of buying a home, you’re selling yours. It is an option for over 55s who own their existing property outright but want to buy more real estate, possibly for a younger family member.
They can receive a large cash loan based on the value of their property. This money is only repaid if the property is sold or when they pass away from their estate (maybe through the sale of the house).
Can I get a second home equity loan?
It is possible to have two or more home equity loans at once. This will only be possible if your income and financial circumstances prove that you can afford to pay back these loans together. When you apply for a second home equity loan you will need to disclose that you already have an existing loan and possibly a mortgage.
When there is a second or third lien of credit, lenders can have more difficulty recovering money in the event of defaults, and they may be less inclined to lend to you.
Get professional advice first!
The best move you can make is to get professional advice that is personalised to your situation. Armouring yourself with information and options is a great start, and we’ve got more easy-to-read guides here on MoneyNerd.
But before you compare and apply, make sure you speak with a trained professional first. It could save you a costly remortgaging mistake!