There are many ways that homeowners can tap into their home equity to buy a second property. Utilizing a cash-out refinance, a home equity line of credit (HELOCs) or reverse mortgage can help homeowners leverage their current residence to access the cash they need to fund the purchase of their second one.
Pros And Cons Of Using Equity To Buy Another Home
Whether you’re considering buying a rental property or a family vacation home, properties are gaining appreciation faster than in previous years, so now is a good time to invest in Canadian real estate. Before you start looking for a new home, it’s important that you do your homework in regard to how you’ll fund that second property purchase and if using equity is the best route for you. Each equity option has different pros and cons and gives you access to a different percentage of equity under a unique set of terms/conditions so make sure you’ve done your research to choose which is the best route for you based on your personal situation.
Pros
Depending on the amount of equity you’re able to tap into, the loan you receive could be significantly higher than through a personal loan. When you borrow against your home’s equity, your home is used as collateral, so it’s a lower risk scenario for lenders which means you can expect lower interest rates than personal loans and a fairly smooth application process.
Cons
While borrowing against your home’s equity sounds much better than taking on extra debt with an additional mortgage, it’s still money that you owe. If you’re not in a financial position to take on more debt in general, you may not be ready for a second home. If you plan to eventually sell your current home, you need to pay off the equity loan in full so if you’re nearing retirement, thinking about moving or on a fixed income, this may not be a wise choice for you.
Other Options For Buying A Home With Equity
There are a few different ways that you can tap into your home’s value so you can use the equity you’ve built over time, and turn it into the money you currently need to buy a second home:
Cash-out Refinance
A mortgage refinance is the process of getting a new mortgage for your home, whether it’s from your current lender or a new one. You effectively pay off the first loan in full by using the second (new) one which allows you to lock in with a new interest rate and loan term. Keep in mind that this process will bring with it fees and penalties (typically around 3 months’ worth of interest) so make sure the longer term savings make sense compared to the upfront fees in the long run.
In order to pursue refinancing, both you and your home will need to meet some specific requirements regarding how long you’ve owned the home, what your credit score is, your financial history, how much home equity you have built up in the home and your debt-to-income ratio. While the minimum equity requirement varies by lender, you’ll typically need between 15%-20% equity to pursue refinancing.
Home Equity Line Of Credit (HELOC)
A home equity line of credit (HELOC) is a revolving line of credit that lets you borrow the equity in your home at a much lower interest rate than a traditional line of credit. You’ll have to pay interest on the money you borrow through a HELOC but you’re able to borrow and repay over and over as you need cash, up to a certain maximum credit limit. The lender uses your home as a guarantee that you’ll pay back money that you borrow. To apply for a HELOC, you must have at least 20% equity built up in your home.
While a HELOC can be useful for financing the purchase of a second home, there are some limitations you’ll encounter. You can only access a HELOC once you’ve built up at least 20% equity in your current home and you’ll need to have good credit to use the money you’d unlock with the HELOC. It’s worth noting though, that since HELOCs are revolving lines of credit (similar to a credit card), they allow homeowners to access to money at any time and since you don’t need to make a loan payment until you actually spend the money, this route can be helpful for homeowners who need help securing a down payment for a second property.
Reverse Mortgage
A reverse mortgage is a loan that you secure against the value of your home that gives you access to tax-free cash without mandatory ongoing payments. It’s designed for homeowners that are 55+ and it enables you to convert up to 55% of your home’s equity into tax-free cash you can use to pay for a multitude of things, including a second home. If you qualify, how much you will actually get approved for will depend on you and your spouse’s age, the location of your home, the type of home it’s classified as, your home’s appraised value, your home’s condition and how much home equity you have accessible.
The main perk of reverse mortgages when it comes to funding the purchase of a second property is that you won’t have to make payments on your primary residence until you decide to buy another primary residence, move out or pass away. You also don’t owe taxes on any of the money you borrow with a reverse mortgage so if you’re on a fixed income and you meet the criteria for a reverse mortgage, this may be a good option for you. It’s also important to note that it’s possible you may lose equity in your home over time by going this route. Reverse mortgages also tend to have higher interest rates than those on a first mortgage, and the interest begins to accumulate the moment the loan is activated.
Whether it’s a vacation home, rental property or cottage, using your home’s equity can be a great way to finance the purchase of a secondary property you’ve been dreaming of. Learning more about your different equity options and what they bring to the table will help you better understand your choices and select which one is best for you. If you’re interested in learning more about tapping into your home equity or funding the purchase of a second property, reach out to our team of qualified professionals to discuss your options!