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American homeowners are sitting on a significant sum of equity. In fact, the average homeowner has about $298,000 in equity, according to the data firm CoreLogic. That equity can be turned into cash using tools like home equity loans or HELOCs and used to renovate your home, pay off debts, or achieve other financial goals. Some homeowners even use these funds to buy a second house.
But is this a good move for your finances, though? Below, we’ll break down what some experts say about using equity to buy another property.
See what home equity loan interest rate you could qualify for here now.
Should you use home equity to buy a second home?
Here’s when some experts think you should use home equity to buy a second home – and when they think you shouldn’t.
When you should use home equity to buy a second home
Home equity can be an easy choice for funding a second home purchase — especially if you don’t have the savings to do so otherwise.
“The advantage of using a HELOC for a second home purchase is that you don’t have to raise cash — say, by selling stocks or liquidating other assets,” says Lynnette Khalfani-Cox, founder of The Money Coach.
But the move is only smart if you’re careful. For one, you’ll need to have the monthly income to handle both payments — your main mortgage and your HELOC. You will also need to be confident in the strength of your local housing market and that your current home’s value will remain high. If your home value drops, you could end up owing more on your home than it’s worth.
“Taking out a HELOC increases your monthly debt payments and obligations, so you need to take a very good look at your budget and income stability to ensure you are able to comfortably make this new payment,” says Mason Whitehead, branch manager at Churchill Mortgage. “Also, you create risk for a domino event if you have a HELOC on your primary residence and other properties as well. If the market moves negatively or you have a job or income loss issue, you are at risk of losing multiple properties if you are unable to keep the payments current.”
You should also be confident in your second home’s value before using equity to pay for it. Will the home it appreciate in value over time? If you plan to rent it out, will you be able to keep it booked and bringing in income? Plotting the future of the property is critical, experts say.
“Conduct thorough research of the real estate market — especially in the area you plan to buy your second home,” says Vikram Gupta, head of home equity at PNC Bank. “This will allow you to better understand the potential returns compared to the risks.”
Learn more about your home equity options here today.
When you shouldn’t use home equity to buy a second home
You shouldn’t turn to home equity if your income is inconsistent or you might have a change in income or jobs soon. As Whitehead puts it, “You need to consider your income stability and potential ‘what if’ scenarios before taking out any debt — especially one tied to your primary home. Make sure your income is consistent and that you are comfortable with a decline in income.”
Consistent income is particularly important if you’re getting a HELOC, as they usually have adjustable interest rates. This means your rate and monthly payment could rise over time. You’ll need to be sure you have enough cash to cover those increased costs — as well as the payments on your existing mortgage, too.
“Ultimately you could face a double whammy,” Khalfani-Cox says. “The HELOC could adjust upwards, and if you took out a loan to buy that second property and you used an adjustable-rate mortgage, that loan could adjust also, giving you payment shock.”
Finally, tapping your equity isn’t wise if home values are declining in your area. If home values drop, you could find yourself in a negative equity situation. If this occurs, you will owe more on your mortgages than the home is worth — and even selling the property wouldn’t be enough to pay off your loans.
Shop around for your home equity loan or HELOC
If you do choose to leverage your home equity for a new home purchase, run the numbers with a loan officer first to make sure it’s a smart financial choice. You should also shop around for your lender, as rates, fees, terms, and qualifying requirements can vary from one company to the next.
