Can You Use Equity to Buy Another House?

Using the equity built in a home can provide a pathway for purchasing an additional property. Home equity represents a homeowner’s stake in their property, allowing access to funds for investments. Understanding how to access this equity is a fundamental step in this financing strategy.

Accessing Home Equity

Home equity is the difference between a home’s current market value and the outstanding mortgage balance. This value increases as mortgage principal is paid down and as the property’s market value appreciates over time. Homeowners can access this accumulated value through several financial products, each designed to provide funds in distinct ways.

A Home Equity Line of Credit, or HELOC, functions as a revolving line of credit secured by the home. Funds can be borrowed, repaid, and re-borrowed up to an approved limit during a “draw period,” typically 5 to 10 years. Payments are often interest-only during the draw period, offering flexibility. Principal and interest payments begin during the subsequent repayment period, which can extend for 10 to 20 years. HELOCs feature variable interest rates, meaning payments can fluctuate with market conditions.

A Home Equity Loan, often referred to as a second mortgage, provides a lump sum of money upfront. This loan is repaid through fixed monthly installments over a set term, which can range from 5 to 30 years. Unlike a HELOC, home equity loans typically have fixed interest rates, providing predictable monthly payments. This structure suits homeowners needing a specific amount for a one-time expense and preferring stable repayment terms.

A cash-out refinance involves replacing the current mortgage with a new, larger mortgage. The difference between the new loan amount and the existing mortgage balance is provided to the homeowner in cash at closing. The entire loan, including the original mortgage and the cash-out portion, will have new terms and a potentially new interest rate. Cash-out refinances access a substantial amount of equity in a single transaction.

Applying Equity Funds to a New Home Purchase

Funds from a HELOC, home equity loan, or cash-out refinance can be applied towards acquiring another property. A primary use is to cover the down payment on the new home. Utilizing equity allows a buyer to avoid liquidating other assets or to make a larger down payment, potentially securing more favorable mortgage terms.

Beyond the down payment, these funds can also cover closing costs for the new home purchase. Closing costs typically range from 2% to 5% of the loan amount, encompassing fees for appraisals, title insurance, and administrative expenses. Using equity to cover these costs can reduce out-of-pocket expenses at closing.

Timing is a practical consideration when using equity for a new home. A HELOC can be useful as a bridge loan if a homeowner intends to purchase a new property before selling their current one. The revolving nature of a HELOC allows funds to be drawn as needed for the new purchase and then repaid once the existing home is sold. This flexibility can help manage the financial gap between selling one property and buying another.

Transferring and applying these funds during the home buying process is straightforward. Lump sums from home equity loans or cash-out refinances, or draws from a HELOC, are typically deposited into the homeowner’s bank account. These funds then become available to be wired or transferred as part of the down payment and closing costs for the new property, following standard real estate procedures.

Key Financial and Eligibility Factors

Lenders assess several financial and eligibility factors when evaluating applications for home equity products. A strong credit score is an important requirement, with many lenders seeking a FICO score of at least 620 to 680 for approval. Higher scores often result in more favorable interest rates and terms. A review of the applicant’s credit history, including timely payment records, is a standard part of the evaluation.

The debt-to-income (DTI) ratio is another important metric, calculated by dividing total monthly debt payments by gross monthly income. Lenders prefer a DTI ratio below 50%, with some requiring it to be as low as 43%, to ensure the borrower can manage additional debt. This ratio helps lenders gauge the applicant’s capacity to take on new payment obligations.

The loan-to-value (LTV) ratio is a measure of the amount borrowed against the home’s appraised value. For equity products, lenders require homeowners to retain a certain percentage of equity, allowing borrowing up to 80% to 85% of the home’s value, including any existing mortgage. This ratio, sometimes referred to as combined LTV (CLTV) when considering both the primary mortgage and the new equity loan, dictates the maximum amount of equity that can be accessed.

A home appraisal is required to determine the current market value of the property, which directly impacts the available equity and the LTV calculation. The appraised value establishes the baseline for how much a homeowner can borrow. A lower-than-expected appraisal could limit the accessible funds, influencing the financial strategy for a new home purchase.

Understanding the interest rates and repayment structures of these equity products is important. While home equity loans offer fixed rates with predictable payments, HELOCs have variable rates, meaning monthly payments can increase if interest rates rise. Borrowers should consider the potential for payment fluctuations, particularly with HELOCs, and plan their budget accordingly. Lenders also verify income stability through documentation such as pay stubs and tax returns to confirm a borrower’s ability to meet the new debt obligations.