Introducing the idea of using a home equity line of credit or a home equity loan to finance a second mortgage can be exciting for homebuyers looking to purchase a vacation home, investment property, or future retirement home. However, navigating the different equity loan options can also feel complicated.
This in-depth guide will explain everything you need to know about tapping home equity to buy a second home. You’ll learn how equity loans and home equity lines of credit work, the amount you may qualify to borrow, risks to understand, and tips from finance experts across Canada on using equity strategically.
Read on to explore how to turn the equity in your home into an opportunity to grow your assets into a bright financial future.
Understanding Home Equity and How to Calculate It
Simply put, home equity refers to the current dollar value that you own in your home, based on its fair market value and your remaining mortgage principal.
As you pay down your mortgage or property values in your area rise, the equity you hold in your home grows over time. For example, if your home is worth $800,000 today and you still owe $300,000 on your mortgage, you have $500,000 in equity built up.
Calculating Your Home Equity
Determining how much equity you have available works through a simple calculation:
Current Home Value – Remaining Mortgage Owed = Your Home Equity
To find your home’s current value, use free online valuation tools or contact a licensed appraiser. This will give you an estimate based on recent sales of comparable properties in your neighborhood.
Compare this number to your remaining mortgage balance, which you can find on your lender statements. The difference between the two is your estimated home equity.
Factors That Affect Home Equity
Several key factors impact how much equity you are building in your home over time:
- Making Regular Mortgage Payments – More of your mortgage principal gets paid off each month by making payments as scheduled. This drives up the stake of value you own.
- Changes in Home Value – As housing markets shift, changes in your home’s fair market value also impact your equity position. In many cases, values rise over time leading to equity growth. However, market fluctuations can sometimes also lead to periods of decline.
- Home Improvements – Investing in upgrades like kitchen renovations, finished basements, and swimming pools can boost your home’s value over time. However, the return on investment varies based on the projects.
Carefully tracking these factors empowers you to make strategic decisions about when to access your home’s equity, if needed, to achieve financial goals like buying a vacation property.
Types of Home Equity Loans to Finance a Second Home
With a solid handle on your current equity position, you can explore different equity financing options for a second home purchase. While accessing additional funds, each product provides varying degrees of flexibility, rates, and risks to understand before moving forward.
Home Equity Line of Credit (HELOC)
A flexible option, a home equity line of credit uses your home as collateral while providing access to a revolving credit line. HELOCs offer lower interest rates than key alternatives, yet rates remain variable.
Directly tied to your residence, a standalone second mortgage gives you a fixed lump sum loan amount to tap extra equity above what’s allowed in your first mortgage. Second mortgage rates tend to be higher than original mortgages and approval requirements stricter.
With today’s low rates, many choose to refinance their current mortgage to gain equity access for a second home, cash-in-hand through a lump sum payout. This route may allow 80% total lending against your home’s value and allow you to blend variable and fixed rate portions.
An option generally for those 55 and older, a reverse mortgage unlocks equity without requiring any repayment until a future trigger event like moving out or death. As fees and closing costs apply, ensure you understand all conditions before obtaining funds through this route.
Home Equity Sharing Agreement
As an alternative approach, home equity sharing agreements allow you to sell a pre-defined stake in your home’s equity growth potential to an investor in exchange for cash – without monthly payments. The investor then shares in appreciation when you eventually sell. As a newer financing option, read the fine details first.
Using a Home Equity Loan to Buy Second Home
How to Access Home Equity
To obtain approval for equity financing, lenders review your income, employment status, credit score, and history of mortgage payments among other validation checks, to ensure you qualify and can manage the additional debt.
Prepare in advance by getting your financial house in order. Pay down existing debts, maintain timely mortgage payments, and keep credit card balances low to position your profile attractive to lenders.
Amount of Equity You Can Borrow
Depending on the product, lenders typically allow you to access 65 to 80 percent of your home’s value, including your current mortgage balance. Do the math to understand how much equity you need for a down payment on your second property.
Interest Rates and Terms
Carefully compare interest rates and attached terms across banks and alternative lending options through online comparison tools. Second and reverse mortgages generally impose higher than average rates due to their risk profiles. Seek professional advice to ensure you pursue the most strategic debt product for your situation.
Getting the Money
Once approved, second mortgage loans generally pay out funds in a lump sum for you to use immediately for a downpayment or to purchase the second property in cash. HELOCs instead work like a credit card with an open line of credit to draw from as needed. Understand the flexibility of payment you require before submitting applications.
Tips for Using Home Equity to Buy a Second Property
Calculate Costs and Repayment Ability
Beyond just a down payment, budget for all expected costs when owning a second home – like closing fees, future repairs, condo fees, higher property taxes, utilities, and upkeep expenses. Also, scrutinize your ability to manage higher debt repayment and interest costs long-term.
Compare Interest Rates and Fees
As second mortgages and lines of credit impose higher than average rates, shop multiple banks and alternative lenders to secure the most competitive offer before signing on the dotted line. Pay close attention to rates and attached fees which vary widely across lender options.
Understand the Risks
Using leverage introduces risks, like falling short of repayment responsibilities or seeing home values dip, leading to negative equity between what you owe versus current value. Take steps to keep mortgage payments on track by setting up automatic transfers. Also, get insurance to protect your assets in a down market.
Consult a Mortgage Professional
Contact an experienced broker or advisor to receive tailored advice, assess the pros and cons, run the numbers, and model out worst and best-case scenarios before tapping equity. Their guidance can prove invaluable in using leverage safely.
Have a Backup Plan
Using equity to gain extra capital offers flexibility. However, budget in case plans for a vacation property don’t pan out as modeled. Maintain an emergency fund for unexpected costs and keep an affordable mortgage balance on your primary home if a future sale is required.
Alternative Online Lenders Can Also Help Access Funds
While tapping home equity is one route to finance property investments, qualifying can be challenging for some buyers. Luckily, modern alternative online lenders like Cash in 24 also help fill this need.
Cash in 24 provides fast, flexible personal loans from $350 to $50,000, with pre-approvals in as little as 1 hour. They accept applicants across all credit backgrounds and use assets like your home, car, or investments as collateral while avoiding strict credit checks.
Once approved, funds can be deposited directly into your bank account within 24 hours.
So, if capital is needed to jump on time-sensitive property deals, Cash in 24 facilitates a streamlined way to access equity funds rapidly.