When you own a home, you have the ability to accumulate equity, which is the value of your home minus any loan balance you have on it. You can increase your home’s equity by making improvements to your home, paying off your mortgage, or even just sitting back while your home’s value appreciates over time.

Once you have equity, you can turn it into cash using a home equity loan. These loans are types of second mortgages that allow you to borrow against your capital and recover part of it in cash. You then repay the loan in monthly installments, often over many years.

How home equity loans work

Home Equity Loans allow you to borrow against the value of your home that you own and convert it into a lump sum cash payment. You can then use these funds as you see fit.

Get a home equity loan works much like getting a traditional mortgage. You will complete an application, submit financial documents such as bank statements, pay stubs, tax returns and W-2 forms, then close your loan. One of the differences between home equity loans and applying for a traditional mortgage is that you may not owe closing costs, although that depends on the lender you choose.

To qualify for a home equity loan, you will generally need:

  • A credit score of 680 or higher

  • A debt-to-income ratio (DTI) of 45% or less

  • At least 10% to 20% equity in your home

Once approved for a home equity loan, you will receive the funds a few days after closing. You will start repaying the loan immediately, via fixed monthly payments.

Can I take out a mortgage to buy a second home?

The short answer is yes, you can use a home loan to buy a second home. Since the proceeds from a home equity loan can be used for any purpose, this means that you can use the money to purchase additional real estate if you wish.

However, this carries risks. As Adam Spigelman, senior vice president at Planet Home Lending, explains, “You can use a home loan to buy another property – just make sure you’re comfortable using your home to secure it. .”

Here’s an overview of the pros and cons of using a home loan to buy a second home.

Benefits of using a home loan to buy a second home

Using a home loan to purchase real estate can often be beneficial, allowing you to keep your savings intact, spread the costs of your purchase over a long period of time, and enjoy reliable monthly payments.

Here is an overview of the advantages of this strategy:

  • You get a large sum of money, which you can use as a down payment or to buy an entire property.

  • Interest rates are fixed, meaning you get a consistent monthly payment for the life of the loan.

  • There are many repayment terms to choose from, ranging from five to 30 years.

  • You don’t have to dip into your savings, emergency fund or retirement accounts to pay for the purchase of your second home.

  • It may be easier to qualify than a second home mortgage, as lenders consider it less risky.

Disadvantages of using a home loan to buy a second home

Despite the advantages of the strategy, using home equity to buy a second home is not without risk. For one, these loans add a second monthly payment on top of your mortgage. They also use your home – the place where you and your loved ones live – as collateral, so if you don’t meet your payments, the lender can foreclose on your home.

“If you can’t make both payments, you’ll fall behind very quickly,” says Jim Black, director of loans at InstaMortgage and advisor at Calque Lending. “You can literally lose everything.”

Other disadvantages include:

  • This puts your principal residence at risk of foreclosure if you cannot make your payments.

  • Home equity loans add a second monthly payment, which could strain your household budget.

  • This could mean that you owe more than your home is worth if your home’s value drops in your area.

Using a home equity loan to buy an investment property

You can also use home equity loans to purchase an investment property. This could mean taking out an equity loan in your primary residence or second home (if you have one). Then you will use these funds as a down payment on the investment property or to purchase it outright.

This strategy has both advantages and disadvantages. On the one hand, it could make it easier to get a loan. On the other hand, you’ll need to be very careful about the property you buy, especially if you plan to use its earnings to cover your payments.

Here is an overview of the full range of advantages and disadvantages of this strategy.

Benefits of using a home equity loan to buy an investment property

One of the benefits of using a home equity loan to purchase an investment property is that it can be easier to qualify for than other options. Mortgages for investment properties tend to have stricter requirements than home equity loans, and they are often more expensive.

There are other advantages to using a home equity loan: “The advantage of using a home equity loan is that the interest rate can be lower,” says Spigelman.

Other benefits include:

  • You get a large sum of money, which you can use as a down payment or to buy an entire property.

  • Interest rates are fixed, meaning you get a consistent monthly payment for the life of the loan.

  • There are many repayment terms to choose from, ranging from five to 30 years.

  • You don’t need to dip into your savings, emergency fund, or retirement accounts to pay for the purchase of your second home.

  • It may be easier to qualify than a traditional loan, and interest rates may be lower.

Disadvantages of using a home loan to buy an investment property

There are no additional requirements for using a home equity loan for an investment, although there are some unique considerations you should take into account, especially if you plan to use the income. property to cover your payments.

“You’ll need to make sure that the property you want to buy will actually generate income,” says Alex Shekhtman, CEO and Founder of BLC Mortgage.

To do this, consider working with a real estate agent. They can help you understand local market conditions and ensure you are investing in an area that is in demand.

You should also consider the additional costs associated with an investment property, including maintenance, cleaning, restocking of supplies, and, if using a property management company, the cost of these services.

“You’ll want to weigh the short-term aspects of the current buying environment against the potential long-term outlook for the property,” says Black. “You’ll also want to budget to make sure you have cash on hand for repairs or unplanned vacations or off-peak seasons.”

Other disadvantages of this funding strategy include:

  • This puts your principal residence at risk of foreclosure if you cannot make your payments.

  • Home equity loans mean an extra monthly payment, which could strain your household budget.

  • This could mean you owe more than the value of the property if home values ​​go down in your area.

  • There is no way to guarantee that the property will generate income, so it may be difficult to make payments if you rely on this income.

  • You will need to consider other costs, such as maintenance and cleaning, as well as possible future vacancies.

The take-out sale

If you are considering buying a second home or an investment property, a home equity loan is a financing option worth exploring. But remember: they come with risk, especially if you’re borrowing against the equity in the home where you live.

Before applying, do the math. Make sure you have the funds to comfortably cover your payments, on both your primary mortgage and home equity loan, not just today, but for the long term as well.

“A home equity loan is a type of secured loan, which means that if you fail to repay the loan, your lender could foreclose on your home,” says Shekhtman. “It’s important to make sure you can comfortably make the monthly payments before you take one out.”

This story was originally featured on Fortune.com

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