Can You Use Equity in One House to Buy Another?

Home equity represents the portion of your home’s value that you own. It is calculated by subtracting your outstanding mortgage debt and any other liens from your property’s current market value. As you make mortgage payments and your home potentially increases in market value, your equity grows. This accumulated equity can be leveraged to facilitate the purchase of another property.

Methods for Accessing Home Equity

Homeowners can access equity through distinct financial products. Lenders assess a borrower’s credit score, debt-to-income (DTI) ratio, and the property’s loan-to-value (LTV) ratio to determine eligibility and loan terms.

A Home Equity Loan (HEL) functions as a second mortgage, providing a lump sum. This loan comes with a fixed interest rate and a predictable repayment schedule, often spanning 5 to 30 years. To qualify, lenders require a credit score of 620 or higher, though higher scores can lead to more favorable rates. Borrowers need to maintain a combined loan-to-value (CLTV) ratio of at least 80%, meaning they must have at least 20% equity. Income verification and a property appraisal are typically required.

A Home Equity Line of Credit (HELOC) operates like a revolving credit line, similar to a credit card, allowing borrowers to draw funds as needed up to a set limit. HELOCs feature variable interest rates and have two phases: a draw period (usually 5-10 years) followed by a repayment period. During the draw period, borrowers may only be required to make interest-only payments. Eligibility criteria include a credit score above 680, a manageable debt-to-income ratio, and sufficient home equity, with many lenders requiring at least 15-20% equity. Income documentation, current debts, and homeowners insurance are typically required.

A cash-out refinance involves replacing your existing mortgage with a new, larger one, and receiving the difference in cash at closing. This method allows homeowners to access a portion of their equity while securing a new interest rate and repayment terms. Lenders require a credit score of 620 or higher, a debt-to-income ratio of 43% or less, and at least 20% equity to qualify. The amount of cash accessible depends on the home’s value and the lender’s loan-to-value limits.

A bridge loan is a short-term financing solution designed to “bridge” the gap between buying a new home and selling an existing one. These loans are used to cover a down payment or closing costs on a new property before the sale of the current home is finalized. Bridge loans are characterized by their short terms, typically 6 to 24 months, and carry higher interest rates than traditional mortgages. Lenders evaluate the equity in the existing property and look for a strong credit score, above 700, along with a debt-to-income ratio below 36%.

Applying Accessed Equity to a New Home Purchase

Once a homeowner has accessed equity from their current property, these funds can be deployed for a new home purchase. The accessed equity provides liquid capital and flexibility. This financial maneuver can influence the terms and competitiveness of a new home offer.

The most common application of accessed equity is to fund the down payment. A substantial down payment can reduce the amount needed for a new mortgage, leading to more favorable loan terms and lower monthly payments. Lenders view these funds as liquid assets, bolstering the buyer’s financial standing. A larger down payment can also improve the buyer’s loan-to-value ratio on the new mortgage, which is seen positively by lenders.

In competitive real estate markets, accessed equity can enable a buyer to make a cash offer, or a larger down payment, which can make their offer more attractive to sellers. A cash offer can streamline the transaction process by eliminating financing contingencies and allowing for a faster closing. Even if a full cash purchase is not feasible, a larger down payment can signal financial strength and reduce the perceived risk for the seller.

When applying for a new mortgage, the lender will consider the new debt incurred from accessing equity. This additional debt will impact the borrower’s debt-to-income (DTI) ratio, a factor in mortgage qualification. Lenders assess DTI to ensure the borrower can manage their monthly debt obligations. A higher DTI could limit the amount a borrower can qualify for on the new mortgage or necessitate a higher credit score for approval.

Timing and coordination are important. The funds must be available when needed for the new property’s closing, requiring planning with both the equity loan provider and the new mortgage lender. Ensuring that closing dates align and that funds transfer smoothly can prevent delays and additional costs in the real estate transaction.

Financial and Practical Considerations

Leveraging home equity involves an evaluation of ongoing financial obligations and practical challenges. Taking on additional debt requires understanding its implications beyond the initial transaction. This approach can lead to complexity in personal financial management.

One consideration is the debt burden, as homeowners will be carrying multiple loans. This includes the original mortgage, the new loan from accessed equity, and the mortgage on the newly acquired property. Managing these multiple payment obligations demands budgeting to avoid financial strain. The collective monthly payments will represent a larger portion of a homeowner’s income, highlighting the importance of a financial plan.

Interest rates and repayment terms are important. Home equity loans have fixed rates, offering predictable payments, while HELOCs have variable rates. The interest rates on these equity products may be higher than those on a primary mortgage, increasing the cost of borrowing. Understanding the repayment schedule for each loan, including any interest-only periods for HELOCs, is necessary to manage cash flow.

Taking on additional debt directly impacts the debt-to-income (DTI) ratio, a metric lenders use to assess repayment ability. A higher DTI ratio can make qualifying for the new home’s mortgage more challenging, as lenders prefer a DTI below a certain threshold, often around 43%. Even if initially approved, a rising DTI due to new debt can limit future borrowing capacity. Maintaining a DTI is important for financial flexibility.

Regarding tax implications, the interest paid on home equity loans or HELOCs may be deductible under conditions. IRS guidelines state the interest is deductible if the borrowed funds are used to buy, build, or improve the home that secures the loan. For loans taken out after December 15, 2017, the deduction is limited to interest on up to $750,000 of home acquisition debt. If the funds are used for purposes unrelated to improving the property securing the loan, such as purchasing a second home, the interest may not be tax-deductible. Consulting a tax professional is advisable for guidance.

The practical aspects of maintaining two properties, even temporarily, require consideration. Owning multiple homes incurs additional expenses such as property taxes, utilities, insurance, and maintenance costs. These costs can accumulate quickly and must be factored into the financial assessment. Managing two properties can demand more time and effort for upkeep and oversight, especially if they are not in close proximity.

Property appraisals and loan-to-value (LTV) ratios are important for accessing equity and securing a new mortgage. The amount of equity that can be accessed is tied to the appraised value of the existing home and the lender’s LTV limits. Similarly, the LTV of the new property will determine the maximum mortgage amount available. Fluctuations in property values can impact the available equity or the terms of future loans, making market conditions a factor.