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A home equity loan can make buying a second property less expensive and give more liquidity to the buyer. When using home equity specifically to buy an investment property, there are a few distinct advantages.
You Could Increase Your Down Payment
Home equity loans are received in a lump sum payment, giving you more cash to use toward your next property. By choosing to put more of that money toward your down payment, you can potentially lower your monthly payments and interest rates.
You Could Solve Financing Challenges
Second properties are typically more difficult to finance due to stricter down payment requirements, making a home equity loan a more convenient and affordable solution for most borrowers.
Interest Rates Will Likely Be Lower
Lenders spend less time originating home equity loans, which may save you money, as it typically means lower fees and closing costs. But perhaps the biggest advantage of this option is the potential to lower your interest rates.
Home equity loans offer lower interest rates because they are secured by collateral in the form of real estate. This means by utilizing a home equity loan, you can avoid the hefty interest rates you would encounter through other forms of financing, like hard money and personal loans.
Disadvantages Of Using Home Equity To Buy An Investment Property
Despite the benefits of using home equity to buy an investment property, there are also some potential risks.
You Are Trading Assets In For Debt
Getting a home equity loan means turning assets into debt because you are effectively taking the part of your home that you own and tying it up in another loan. Although this may be worth it in some scenarios as it prevents you from having to withdraw money from existing investments, there are also implications to having higher debt that you must consider.
You Are Leaving Yourself Vulnerable To Shifts In The Housing Market
All homeowners are technically vulnerable to these shifts, but by owning two properties, you are essentially doubling your potential risk to changes in the housing market. If either home’s value lessens, you may end up owing more on your mortgage and home equity loans, which can spread some homeowners too thin.
And if you default on the loan, you could potentially lose both your primary and secondary properties, as both are held as collateral. You should also note that reduced market values could affect your ability to resell the investment property.
You Could Have Three Mortgages For Only Two Homes
A home equity loan is often taken out in the form of a second mortgage. Combine this with the financing you will need for your second home, and it’s likely you will end up with three mortgages for only two properties.
Although this is important to remember, it’s not necessarily a deal breaker, as it’s no worse than having two mortgages and another loan – which would likely have higher interest rates.
Your Home Equity Loan Interest Payments Will Likely Not Be Tax-Deductible
In 2018, changes to tax codes led to somewhat ambiguous guidelines for investment properties. Because of this, we recommend consulting with an accountant before making any decisions. However, if the home equity loan is not specifically being used to improve the property it was taken out against, it’s likely it will not be tax deductible.
The Bottom Line: Using Home Equity To Buy A Second House Comes With Risks, But It’s A Solid Option
Can you use home equity to buy a second home or an investment property? The answer is yes – and there are some significant benefits to doing so. But as with anytime you take on debt, there are also some potential risks. To ensure your financial success, I recommend analyzing all of the pros and cons before taking action.
