Can You Use Equity From One House to Buy Another?

Leveraging home equity can be a strategic financial move for homeowners. Using this accumulated value to acquire another residence is a viable option. This approach can provide capital for a down payment, cover closing costs, or enable an outright cash purchase, streamlining the transition to a new home.

Understanding Home Equity and its Access

Home equity is the portion of your home you own outright, representing the difference between its current market value and outstanding loan balances. Equity grows as you make mortgage payments and as the property’s value increases. For instance, if a home is valued at $400,000 with a $100,000 mortgage, the homeowner has $300,000 in equity. This value can fluctuate with market conditions. Homeowners access equity through several financial mechanisms.

A Home Equity Line of Credit (HELOC) functions as a revolving line of credit, similar to a credit card, allowing you to borrow funds as needed up to a set limit. Interest is typically paid only on the amount borrowed, and rates are often variable, though some lenders offer fixed-rate options for specific draws. Most HELOCs allow borrowing up to 80% or 85% of your home’s appraised value minus your existing mortgage balance.

Another option is a Home Equity Loan (HEL), which provides a lump sum of cash upfront. This “second mortgage” typically comes with a fixed interest rate and a predictable repayment schedule, with terms often ranging from 5 to 30 years. Like HELOCs, HELs are secured by your home, and lenders commonly allow borrowing up to 80% to 90% of the home’s appraised value, factoring in the existing mortgage. Closing costs for HELs generally range from 2% to 6% of the loan amount, covering fees such as appraisals, credit reports, and origination.

A cash-out refinance involves replacing your current mortgage with a new, larger one, receiving the difference in cash. This method allows you to access a portion of your home’s equity in a single lump sum. Typically, lenders require you to maintain at least 20% equity in the home, meaning you can often borrow up to 80% of your home’s value, including the new mortgage balance. Selling your current home is another way to access equity, as sale proceeds become available cash.

Applying Accessed Equity to a New Home Purchase

Accessed equity can be applied to purchase a new property. A common use is for the down payment on the new home. Utilizing a significant portion of the equity as a down payment can reduce the amount needing to be financed, potentially leading to lower monthly mortgage payments and avoiding private mortgage insurance (PMI) if 20% or more of the new home’s purchase price is paid upfront.

In situations where substantial equity is available, it might allow for a full cash purchase of the new home. This eliminates the need for a new mortgage entirely, simplifying the buying process and avoiding interest payments. While a full cash purchase is less common, it offers considerable financial freedom and can make an offer more attractive to sellers in a competitive market.

Accessed equity can also serve as a form of temporary bridge financing. Funds from a HELOC might be used to cover the down payment or even the full purchase price of a new home while awaiting the sale of the current residence. Bridge loans are short-term solutions, typically lasting six to twelve months, designed to “bridge the gap” between buying a new property and selling an old one. These loans are often secured by the current home and may feature interest-only payments until the original property sells.

Accessed equity can also cover various closing costs for the new home purchase, such as loan origination fees, appraisal fees, title insurance, and legal fees. Using equity for these expenses reduces out-of-pocket cash at closing.

Financial and Logistical Considerations

Accessing home equity for another property involves financial and logistical considerations. Taking on new debt, whether through a HELOC, home equity loan, or cash-out refinance, impacts your overall financial health. Each new loan or credit inquiry can affect your credit score, potentially lowering it temporarily, and increasing your total debt burden.

The addition of new loan payments will directly influence your debt-to-income (DTI) ratio. Lenders use the DTI ratio to assess your ability to manage monthly payments and repay a new mortgage. An increased DTI can make it more challenging to qualify for a new home loan, as it signals a higher financial risk to potential lenders. For example, if a HELOC or home equity loan significantly adds to your monthly obligations, it could push your DTI above the thresholds set by mortgage providers, which often prefer a ratio below 43%.

Accessing equity comes with interest rates and fees. HELOCs often have variable rates, while home equity loans and cash-out refinances involve fixed or variable rates. These loans typically incur closing costs, adding to the overall borrowing cost. Factor these into your budget.

Coordination and timing are also crucial, especially when simultaneously buying and selling properties. Real estate transactions often involve contingencies, such as the sale of the current home, which can complicate the purchase of a new one. The timeline for securing new financing can vary, typically taking 30 to 60 days, and must align with the purchase agreement of the new property. Market conditions, including prevailing interest rates and the state of the housing market, also influence the feasibility and attractiveness of using equity. A seller’s market might allow for a quicker sale of your current home, while rising interest rates could make new loans more expensive.

Tax Implications of Using Home Equity

Using home equity for another property carries specific tax implications. A key consideration is the deductibility of interest paid on home equity loans, HELOCs, and cash-out refinances. Under current tax law, interest on these loans is generally tax-deductible only if the borrowed funds are used to buy, build, or substantially improve the property that secures the loan. This includes using the funds for a new home purchase that serves as a primary or secondary residence.

The deductibility of this interest is subject to certain limitations. For loans taken out after December 15, 2017, the total mortgage debt (including both the primary mortgage and any home equity loans or HELOCs) on which interest can be deducted is capped at $750,000. For those married filing separately, this limit is $375,000. If the loan was incurred before December 16, 2017, a higher limit of $1 million applies ($500,000 for married filing separately). To claim this deduction, taxpayers must itemize their deductions on their federal income tax return, rather than taking the standard deduction.

When selling a primary residence to access equity for a new purchase, homeowners may also benefit from the capital gains exclusion. The Internal Revenue Service (IRS) allows a homeowner to exclude up to $250,000 of gain from the sale of their main home, or $500,000 for those married filing jointly. To qualify for this exclusion, the taxpayer must meet specific ownership and use tests, typically having owned the home and used it as their main residence for at least two out of the five years preceding the sale. This exclusion applies to the profit from the sale, not the total sale price, and helps reduce the tax burden on the equity realized.

Funds from a HELOC, home equity loan, or cash-out refinance are loan proceeds and not considered taxable income. However, any forgiven loan amount could become taxable. Rules for home equity interest deductibility, part of the Tax Cuts and Jobs Act of 2017, are set to expire at the end of 2025, which may lead to future changes.