How to Use Home Equity to Buy Another House
Discover how to strategically leverage your home's equity to finance the purchase of your next property, from funding to repayment.
Discover how to strategically leverage your home's equity to finance the purchase of your next property, from funding to repayment.
Home equity represents the portion of your home that you own outright, reflecting your financial interest in the property. It is calculated as the current market value of your home minus the total outstanding balances of all loans secured by it. This value typically grows over time through consistent mortgage principal payments and any appreciation in the property’s market value. Understanding how to unlock this accumulated value can provide a significant financial resource. This article will guide you through the process of leveraging your home equity to finance the acquisition of another house.
Accessing your home equity involves using financial instruments to convert its value into usable funds. Lenders assess eligibility based on factors like credit scores, debt-to-income ratios, and the home’s appraised value.
A cash-out refinance replaces your existing mortgage with a new, larger one, providing the difference in cash. Qualification typically requires a minimum credit score of 620. The loan-to-value (LTV) ratio is usually limited, often requiring at least 20% equity, meaning the new loan cannot exceed 80% of your home’s appraised value. Your debt-to-income (DTI) ratio is also a factor, with many lenders preferring it to be 43% or lower. The existing mortgage often needs to be at least 6 to 12 months old.
A home equity loan (HEL) is a second mortgage, providing a lump sum with a fixed interest rate and set repayment schedule. Lenders generally require a minimum credit score of 620 and at least 15% to 20% equity. The combined loan-to-value (CLTV) ratio, including your first mortgage and the HEL, is usually capped between 80% and 85% of your home’s value. Your DTI ratio should ideally be below 43%.
A home equity line of credit (HELOC) offers a revolving credit line secured by your home. You can draw funds as needed up to an approved limit during a draw period, with interest charged only on the amount borrowed. HELOC requirements often mirror home equity loans, usually needing a credit score of at least 620. Lenders commonly require at least 15% to 20% equity, with CLTV ratios not exceeding 80% to 85%. A DTI ratio below 43% is typically sought.
A bridge loan is a short-term financing option covering the gap between buying a new home and selling your existing one. Secured by your current home, it’s repaid once that property sells. Qualification usually requires at least 20% equity. Lenders review your credit score and DTI ratio, with some requiring a credit score of 700 or higher and a DTI below 50%. Bridge loans generally have terms from six months to three years.
Lenders require documentation to verify your financial standing. This includes proof of income (pay stubs, W-2s, or tax returns for self-employed), statements for current debts, and account balances. A valid homeowner’s insurance policy is necessary, and a property appraisal will determine your home’s market value and confirm equity.
The application process begins with identifying suitable lenders. Many financial institutions, including banks, credit unions, and online lenders, offer these options.
After selecting a lender, submit your application with documentation, including proof of identity, income verification, and details about your current mortgage and property. Lenders review this to assess your financial capacity and eligibility.
The underwriting process follows submission. Underwriters examine documents to evaluate lending risk, reviewing your credit history, income stability, and debt obligations to ensure you meet guidelines and can manage the new debt.
A crucial step is the property appraisal. The lender arranges for a licensed appraiser to determine your home’s market value. This appraisal confirms available equity and helps establish the maximum loan amount, typically capped at an 80% to 85% loan-to-value ratio. While a full appraisal is common, some lenders may use automated valuation models or exterior-only appraisals, particularly for HELOCs or smaller loan amounts.
The final stage is closing. If approved, you sign loan documents, obligating you to the terms. This typically occurs at a title company or attorney’s office. Funds are then disbursed as a lump sum for home equity loans and cash-out refinances, or made available for drawing for HELOCs. The entire process, from application to funding, can take several weeks.
Accessed home equity primarily serves as capital for the down payment on a new property. A substantial down payment can reduce the new mortgage amount, potentially leading to lower monthly payments and more favorable interest rates.
Beyond the down payment, these funds can cover closing costs for the new home purchase. These expenses typically range from 2% to 5% of the purchase price and include loan origination fees, appraisal fees, title insurance, and legal fees. Using equity funds for these costs preserves liquid savings.
In situations where there is a time gap between selling your current home and moving into the new one, accessed equity can provide financial flexibility. It can temporarily cover living expenses, such as rent for a short-term rental or temporary storage costs for your belongings. This ensures a smoother transition and avoids financial strain during the interim period.
The accessed equity integrates into the financing structure for your new home. A home equity loan provides a lump sum for down payment and closing costs. A HELOC allows drawing funds as needed for these obligations, leveraging your existing asset for the new property.
Repaying the funds accessed from your home equity is a distinct financial obligation separate from the mortgage on your newly purchased home. Each type of equity access product has a unique repayment structure.
With a cash-out refinance, your original mortgage is replaced, and the new, larger loan incorporates the cash-out amount. This means you will have a single new mortgage payment with a potentially higher principal balance and a new interest rate, which could be fixed or variable. The repayment schedule for this new loan will typically span a long term, such as 15 or 30 years, amortizing the entire new loan amount.
A home equity loan (HEL) involves fixed monthly payments that include both principal and interest over a predetermined loan term, often 5 to 20 years. The interest rate on a HEL is typically fixed, providing predictability in your monthly expenses. This stable payment schedule allows for clear financial planning, as the payment amount will not change throughout the loan’s life.
A home equity line of credit (HELOC) generally has two phases: a draw period and a repayment period. During the draw period, which often lasts 5 to 10 years, you can borrow and repay funds as needed, and you may only be required to make interest-only payments. Once the draw period ends, the repayment period begins, requiring you to make principal and interest payments on the outstanding balance, typically over a 10 to 20-year term. HELOCs often feature variable interest rates, meaning your monthly payment can fluctuate based on market interest rate changes.
Bridge loans are short-term solutions with repayment terms typically ranging from six months to three years. These loans are generally repaid in a lump sum, often from the proceeds of selling your original home. Some bridge loans may require interest-only payments during their short term, with the full principal due at the end. Carrying this additional debt means you must manage two loan payments concurrently until your original home is sold, emphasizing the importance of a timely sale.