How to Buy Another House With Home Equity

When buying another house, understanding how to use your existing home’s equity is a strategic financial approach. Home equity, the portion of your property you own, is a significant resource for this investment. Utilizing this value allows homeowners to expand their real estate portfolio or secure a new primary residence. The process involves evaluating your equity, deciding how to access funds, and navigating the new home purchase.

Understanding Home Equity

Home equity is the financial interest a homeowner has in their property, calculated as the difference between the home’s current market value and outstanding loan balances. For instance, if a home is valued at $400,000 with a $150,000 mortgage, the homeowner has $250,000 in equity.

Equity accumulates as mortgage payments reduce the principal balance. Property value increases, due to market appreciation or home improvements, also boost equity. Conversely, a decline in market value reduces equity. To determine your equity, get an estimate of your home’s market value through a comparative market analysis or appraisal. Subtract your current mortgage balance from this estimate.

Accessing Your Home Equity

Accessing your home equity provides several ways to obtain funds for a new property. One method is selling your current home. The proceeds, after paying off the existing mortgage and covering selling costs, become available for your new purchase. Selling costs typically include real estate commissions (5% to 6% of sale price) and other closing expenses such as transfer taxes and title fees (1% to 4% of sale price). The net amount can be used as a down payment or for the full purchase of a new home.

Alternatively, a cash-out refinance replaces your existing mortgage with a new, larger loan, providing you with cash. This process pays off your original mortgage. Lenders typically limit the loan-to-value (LTV) ratio to 80% of the home’s value, requiring you to retain at least 20% equity. Closing costs for a cash-out refinance usually range from 2% to 5% of the new loan amount, covering origination fees, appraisal fees, and title insurance.

A Home Equity Line of Credit (HELOC) or a Home Equity Loan allow you to borrow against your equity while retaining ownership. A HELOC functions like a revolving credit line, letting you draw funds as needed up to a limit during a draw period (often 5 to 10 years). Interest is paid only on the amount borrowed, and rates are typically variable. A home equity loan provides a lump sum upfront with a fixed interest rate and set repayment schedule. Both are second mortgages, meaning your primary mortgage remains, and these secured loans generally offer lower interest rates than unsecured personal loans, as your home serves as collateral.

Preparing for Your New Home Purchase

After deciding how to access your home equity, prepare for the new home acquisition. Budgeting for the new purchase requires understanding all associated costs beyond the purchase price. This includes new mortgage payments (principal, interest, property taxes, and homeowner’s insurance, or PITI). Additionally, ongoing homeownership expenses like utilities, maintenance, and potential homeowner association (HOA) fees should be considered to ensure the new property aligns with your financial capacity.

Obtaining mortgage pre-approval demonstrates your financial readiness to sellers. Lenders review your income, assets, credit history, and debt-to-income ratio to determine your maximum loan amount. This process requires documentation such as pay stubs, W-2 forms, tax returns, and bank statements. A pre-approval letter strengthens your offer, signaling you are a serious and qualified buyer.

Understanding closing costs for the new home purchase is important for financial planning. These costs are separate from the down payment and typically range from 2% to 5% of the loan amount, varying by location and loan type. Common closing costs include loan origination fees, appraisal fees, title insurance premiums, attorney fees, and recording fees. An estimate of these expenses ensures you are prepared for financial obligations at closing.

The New Home Purchase Process

With accessed home equity and mortgage pre-approval, the new home acquisition process begins. A real estate agent can help identify suitable properties that align with your budget and preferences.

Once a property is identified, making an offer involves submitting a proposal outlining the purchase price, contingencies, and an earnest money deposit. The earnest money (typically 1% to 3% of the purchase price) demonstrates commitment. Your accessed equity funds will primarily contribute to the down payment.

After your offer is accepted, the property enters the “under contract” period. This phase includes a home inspection to assess the property’s condition and an appraisal to confirm its market value for the lender. The lender also proceeds with final mortgage underwriting, verifying financial details. A title search ensures the property has a clear title, free of liens or claims.

The final stage is closing, where all parties sign legal documents, including the promissory note and the deed of trust or mortgage. Equity funds and new mortgage proceeds are applied to the purchase. Ownership of the new home is transferred to you, concluding the process.