How to Use Equity to Buy a New House

Home equity is the portion of your home you own outright, calculated as your property’s current market value minus outstanding loan balances. This value grows as you make mortgage payments, reduce your principal, and as the property’s market value increases. Accessing your current home’s equity can provide financial resources for purchasing a new property. This allows homeowners to utilize wealth built in their existing residence to acquire another.

Methods for Accessing Home Equity

Several financial products allow homeowners to access home equity, each with distinct features for purchasing a new home.

A cash-out refinance replaces your existing mortgage with a new, larger one, converting a portion of your home’s equity into a lump sum at closing. The new loan includes your previous mortgage balance and the additional funds. Lenders generally require you to retain at least 20% equity, limiting the new loan to approximately 80% of your home’s value.

A Home Equity Line of Credit (HELOC) is a revolving line of credit secured by your home’s equity. It provides access to funds up to a pre-approved limit, allowing you to borrow only what you need, when you need it. HELOCs feature a draw period, during which you can access funds and may make interest-only payments. A repayment period then begins, requiring payments of both principal and interest. Most HELOCs carry variable interest rates.

A Home Equity Loan (HEL) provides a lump-sum payment secured by your home’s equity, distinct from a revolving line of credit. This loan, often called a second mortgage, is disbursed in full at closing. It is repaid over a fixed term with consistent monthly payments and a fixed interest rate. Lenders permit borrowing up to 80% to 85% of your home’s appraised value, minus the outstanding balance of your primary mortgage.

A bridge loan is a short-term financing solution to cover the financial gap when purchasing a new home before selling your current one. Secured by your existing home’s equity, it provides funds for a down payment on the new property. Bridge loans have higher interest rates and fees compared to traditional mortgages. Some arrangements allow for interest-only payments or deferred payments until your current home sells.

Alternatively, homeowners can sell their current home first to directly access equity. This method provides the full net proceeds from the sale, after paying off the existing mortgage and selling costs, for use towards a new home. While it eliminates the need for additional loan products and avoids carrying two mortgage payments, it may necessitate securing temporary housing between selling and purchasing the new property.

Information Needed for Equity Access Applications

Before applying to access home equity, homeowners must compile personal and property information. Lenders require this documentation to assess financial stability and determine the eligible borrowing amount.

You will need to provide proof of income, including recent pay stubs (last 30 days) and W-2 forms (past two years). Self-employed individuals submit federal tax returns (previous two years) and current year-to-date profit and loss statements. Lenders also review employment history, looking for a consistent record of at least two years.

Details regarding your existing debts and assets are necessary. This includes statements for bank accounts, investment accounts, and current balances for outstanding loans (e.g., credit cards, student loans, auto loans). This information allows lenders to calculate your debt-to-income ratio, a key factor in their lending decision.

Your credit score and history play a significant role in determining eligibility and interest rate. Lenders perform a credit check to evaluate your repayment behavior and financial reliability. A credit score above 620 to 680 is generally favorable for home equity products. A lower debt-to-income ratio, ideally below 43%, also enhances your application.

Property documentation is important for the application. You will need your most recent mortgage statement, current property tax bills, and proof of homeowners insurance coverage. If your property is in a designated flood zone, a copy of your flood insurance policy will also be required.

A home appraisal determines your property’s current market value. This valuation is crucial for calculating the precise amount of equity available and the maximum loan amount a lender can offer. The appraisal may involve an in-person inspection or a desktop appraisal using public records and market data.

Understanding the fees and costs associated with accessing equity is part of the preparation. Closing costs for home equity loans and HELOCs commonly range from 2% to 6% of the loan amount. These costs can include appraisal fees, credit report fees, origination fees, and charges for document preparation or attorney services.

The Equity Access Application Process

After preparing all necessary documents, the formal application process for accessing home equity begins. The lender evaluates the application, approves financing, and disburses funds.

Initiating the application involves submitting information to your chosen lender. The lender will perform a credit check to assess your financial standing and history.

The application moves into the underwriting phase, a comprehensive review of your financial profile and property. Underwriters examine your income, assets, existing debts, and the property’s value to confirm your ability to repay the loan. The lender will order a home appraisal to verify your home’s current market value and accessible equity. This process, from application submission to final approval, typically takes between two and six weeks.

Upon approval, the lender will prepare the final loan or line of credit agreements. At closing, you will sign all official documents. Applicable closing costs, which vary by loan type and lender, are generally due at this time, though some lenders may allow these fees to be rolled into the loan amount.

Following closing, a mandatory three-day right of rescission period applies for primary residences, during which you can cancel the loan without penalty. Funds are disbursed after this period expires, usually within three to five business days. For a cash-out refinance, you receive a lump sum. HELOC funds become available as a line of credit you can draw upon as needed.

Once funds are received, note the first payment due date for your new home equity product. For HELOCs, the draw period commences, allowing flexible access to the credit line. Maintaining timely payments on this new financial obligation, in addition to your existing mortgage, is important to preserve your financial standing and avoid adverse effects on your credit.

Integrating Equity into Your New Home Purchase

Once home equity funds are accessed, the focus shifts to strategically applying these resources to acquire a new home. This involves considering how funds will be used, timing, and planning for transitional periods.

Accessed equity can be applied towards the down payment for the new property. A larger down payment can reduce your new mortgage’s principal, potentially leading to lower monthly payments and a more favorable interest rate. A substantial down payment (20% or more) can help you avoid private mortgage insurance (PMI) on a conventional loan, saving on ongoing costs. These funds can also cover closing costs, which typically range from 2% to 6% of the new loan amount.

Timing the use of equity with your new home purchase requires careful coordination. Secure your equity financing before making a firm offer on a new property, especially in a competitive real estate market where cash offers or those with substantial down payments are preferred.

For homeowners buying and selling simultaneously, a concurrent or “simultaneous closing” is a common goal. This involves orchestrating the closing of your equity access (or sale of your current home) and the purchase of your new home on the same day or within a very short timeframe. Achieving this demands precise communication and cooperation among lenders, real estate agents, and title companies to ensure all transactions align seamlessly.

If you access equity through a Home Equity Loan or HELOC before selling your current residence, you may temporarily carry two mortgage payments. This financial overlap necessitates robust budgeting and an understanding of your capacity to manage both obligations until your existing home is sold. Bridge loans provide short-term financing to cover this interim period, allowing you to secure a new home without immediate reliance on your existing home’s sale proceeds.

Developing a clear plan and considering contingencies are important for a smooth transition. If your current home’s sale does not align perfectly with your new home’s purchase, you might need temporary housing or a short-term rental. While including a home sale contingency in your new purchase offer can provide protection, it may make your offer less attractive to sellers in certain markets.