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The average American home has appreciated almost 9% in value since 2022, helping homeowners gain $2.8 trillion in tappable equity since June 2021. That breaks down to an average of more than $207,000 of equity per mortgage holder, according to the data and analytics firm Black Knight.¹

Homeowners who have built up their equity may want to tap into that asset, especially when buying a new house. But is it possible to use home equity to purchase a new home? While the short answer is yes, the longer answer is that it’s not as simple as you might want it to be.

The two most common ways to take advantage of your home equity is to use a home equity loan or a home equity line of credit (HELOC). But before you pull equity out of your home, ensure that you understand the risks and rewards of each.

What is a home equity loan?

Home equity loan (also called a second mortgage) allows homeowners to borrow against the equity in their current home, with the loan amount based on the difference between the home’s current market value and the mortgage balance due.��

Like the name “second mortgage” suggests, a home equity loan works like a typical mortgage with a set repayment term and fixed payments that cover both the principal and interest.

Home equity loans are different from a refinance in that they don’t replace your previous mortgage with a new one — these are an additional loan on top of your existing mortgage.

Taking out a second mortgage comes with a lot of risks that can vary depending on what you end up using that money for. We discuss the pros and cons of using a home equity loan for different purposes below:

Using home equity loan for a second home or investment property

It may be tempting to turn all of that untapped capital into a vacation home or investment property. While the advantages of using a home equity loan might seem overwhelming, it’s important to weigh both the pros and cons before following through on that transaction.

Pros

• Lower interest rates: Home equity loans generally have lower interest rates than other types of financing because your primary residence serves as collateral for the loan.
• Larger down payment: The cash you receive from your home equity loan can help you put down a larger down payment or turn you into a cash buyer and make your offer stand out in a competitive market.��
• Easy to qualify: Getting a mortgage for a second property can be difficult, and home equity loans are generally easier to secure.

Cons

• Exchanging assets for debt: The equity in your home is an asset; you own it outright. But when you take out a home equity loan, you use that asset as collateral, turning it into debt. This can have a negative impact on your debt-to-income ratio, which compounds if you take out an additional mortgage on your second property.
• Three mortgages for two homes: Home equity loans are called a second mortgage for a reason — they come at the cost of a lien against your home. If you buy an investment property, you could end up paying three mortgage payments a month for only two properties.
• Interest not tax-deductible: Unless you take out your home equity loan to improve your investment property, the interest you pay on it will likely not be tax-deductible like your mortgage interest payments are.

Using home equity loan to buy a new primary residence

Maybe it’s time to downsize, expand, or you’re moving across the country. Whatever your reasons are, you want to buy a new primary residence. Using the equity in your current home could be a way to make that decision easier, but there are some pros and cons to consider before tapping into that asset.

Pros

• Become an all-cash buyer: It’s no secret that cash offers are the way to stand out in competitive markets. If you’ve built enough equity in your current home, you may be able to take out a loan to make a cash offer on your next home.
• Lower interest rates and fewer fees than alternatives: Home equity loans generally have better rates and terms than other types of loans, like a bridge loan or personal loan, which can keep your costs lower in the long run.

Cons

• You cannot take out a loan after your house is on the market: This option will require some foresight. You will not be eligible for a home equity loan if you apply while your current house is on the market.
• You could face foreclosure: You’ve taken out a home equity loan to serve as the down payment on a new house with a new mortgage. In a worst case scenario, you’re unable to sell your previous home to pay off your previous mortgage and your home equity loan, so now you’re stuck with three mortgages and a house that won’t sell. If you’re unable to make the payments on your home equity loan or mortgage, the bank could foreclose on your house.
• You have to pay closing costs: Home equity loans still have closing costs of 2% to 5%. You may prefer to sell your existing home first to unlock your equity and avoid having to pay these fees in addition to any interest from your loan.

How to use a home equity loan to buy another house

1. Calculate how much you need to borrow: The first step is to determine what you want to borrow, and how much of your equity a lender will let you borrow. Those numbers will help you decide if pursuing a home equity loan is worth it or not.
2. Gather documentation to prepare application: Gather your proof of income and employment, any bank and debt statements, as your credit history, just as you did for your mortgage application. Your lender will need these documents to prepare your loan.
3. Compare rates and lenders: Don’t just go with the first lender that you find — shop around for the best interest rates and terms. Review the terms and conditions carefully to ensure that you won’t end up regretting your decision down the road.
4. Choose lender with best offer and close: Once you’ve decided on a lender, apply for your loan and close.��
5. Accept the funds and buy your new home: Once you’ve received the funds, you can apply them to your new home purchase. The time it takes to actually receive the funds will vary from lender to lender, so it’s worth asking early on in the process to avoid any surprises.

What is a home equity line of credit (HELOC)?

A home equity line of credit, or HELOC, is another option for unlocking some of the latent power of home equity. HELOCs offer homeowners the ability to turn their equity into a line of credit that they can access within a given timeframe called a “draw period.”

Using a HELOC on a second home

The flexibility is beneficial for homeowners who are house flipping or fixing their house up before selling it because it allows them to pay for costs upfront, then repay those costs once the property has sold. It can also be advantageous to homeowners who aren’t sure how much equity they need, as it allows them to only pay interest against what they spend rather than the whole sum they’re eligible to borrow.

However, interest rates for HELOCs are generally variable, so your payments could dramatically change month to month. Be prepared to face fluctuating payments if you use a HELOC to buy another house.

How to use a HELOC on a second home

1. Calculate your available equity: Use a HELOC calculator to determine the home equity you have in your home. Will this amount be enough to cover your planned expenses? If not, you’ll likely need to look into other modes of financing.

2. Prepare your application: Gather necessary documentation, like credit and bank statements, mortgage records, and proof of income. You’ll need these for your application.

3. Shop for the best HELOC lenders and apply: Go to multiple HELOC lenders and review their rates, terms, and conditions. Remember to read the fine print — how long is the advertised interest rate locked in? Will you be able to afford your payments if your rates go up? Once you find a lender with the best offer for your needs, apply.

4. Review your disclosure documents: Once you receive all of the documents, review them once more to ensure that the HELOC fits your needs.

5. Close on the loan: If the loan's terms and conditions work for you, sign and close. You’ll go through an underwriting process but it’s less rigorous than the mortgage underwriting process.

Alternative to using home equity to buy a new home

Homeowners who want to move but aren’t sure how to use their home equity to purchase a new house might consider working with a power buyer, like 91�ƽ��. When you work with us, we’ll guarantee the sale of your current home and turn your home equity into cash that you can put towards the purchase of your next home without the hassle or stress of taking out a second mortgage or line of credit.

Interested in getting more? — our estimates are 30% more accurate.

Article sources:

1. Black Knight: "May sees least affordable housing market in 16 years while existing mortgage holders gain record $1.2 trillion in tappable equity in Q1 2022." Black Knight, Inc.