Put in your second home
According to CoreLogic, the average homeowner raised more than $ 26,000 in home equity in 2020.
If you own a second home or vacation home in a desirable area, you may have made even greater-than-average stock returns.
But what if you want to use that equity? Can you take out a home loan or HELOC for your second home?
The answer may be yes, but the rules are a little different than for your primary home. Here's what you can expect:
Review your home financing options (May 5, 2021).
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Home equity loans and HELOCs for second homess
You don't have to sell your vacation home to access the equity that has been built up.
Instead, you can access the value of your home through a payout refinance, home equity loan, or home equity line of credit (HELOC).
Paying off a second home may be more appealing to some homeowners than changing the mortgage to their primary home or reducing their equity.
Using your second home will reduce the risk of a negative equity position with your primary home if the market worsens.
Fortunately, many lenders and banks offer home equity loans for second homes.
It's a little more complicated when you are trying to refinance a property that is not your primary residence. However, this does not mean that you cannot benefit from historically low interest rates on your homework.
Review your home financing options (May 5, 2021).
Rules for a Second Home HELOC or Home Equity Loan
Because of the increased risk that second homes pose to lenders, second home financing is typically associated with higher interest rates and stricter funding rules.
Buying a second home requires a higher down payment of 10 percent or more. And when you're refinancing a second home that you already own, you'll need enough equity to make the payout worthwhile.
Often times, you need to leave at least 25% of your second home equity untouched, which means you need well over 25% equity for a payout refinancing or home equity loan to be worthwhile.
In addition, the creditworthiness requirements for second homes are higher and the guidelines for the debt-to-income ratio are stricter.
Additional qualifications can be:
Owning the property for at least a year. Higher credit scores (often 680-700+). Larger down payments resulting in lower loan-to-value ratios (LTVs). Geographic location restrictions
The good news is that the rules for second home mortgages are more lenient than those for investment property. This makes it easier to find lenders who offer home equity loans and HELOCs for your vacation home than it is for an investment or rental property.
Home Equity Versus Disbursement Refinancing
Fortunately, despite stricter requirements, you won't be forced to just one loan option to access the equity in your second home.
From a home equity loan to a home equity line of credit to disbursement refinancing, you have alternatives.
Whether you should go for a withdrawal refinance or opt for a home loan will depend on your specific situation.
Home equity loan or HELOC
If you already have a low fixed rate on your existing loan, it is definitely worth considering a home loan. This way, you can keep the interest rate and payment low on your existing mortgage.
Plus, with a home equity loan or HELOC, you don't have to start the loan term from scratch and extend the total duration of the interest payment. This can make a second mortgage more attractive to someone who has almost paid off their existing mortgage balance.
Deciding between a home equity loan or HELOC can be complex. So you should do your research. But here are the basics:
Home equity loans You have to deduct a lump sum from your home, which you usually repay over a set repayment period at a fixed interest rateHome Equity Lines of Credit Take advantage of a revolving line of credit backed by your home equity that you can borrow and repay as many times as you want within a set “draw period”. After the drawing period has expired, you have a fixed period of time to repay the outstanding balance. HELOCs typically have variable rates
Both options are second mortgages. This means that in addition to your existing mortgage loan, you are taking out a new loan. You will then have two monthly payments, probably to two different lenders
If your current mortgage has an above-market interest rate, disbursement refinancing can help you withdraw equity while lowering your interest costs.
Because disbursement refinancing is a “first” or “primary” mortgage, the interest rate is typically lower than a home loan or line of credit, which are both second mortgages.
Just keep in mind that the rules for withdrawal refinancing are stricter for a secondary home than for withdrawing a primary residence.
Expect higher interest rates, higher capital requirements, and higher minimum loan values. In addition, the closing costs for disbursement refinancing are usually higher than for a second mortgage.
Check your Withdrawal Refinancing Eligibility (May 5, 2021).
Why are the rules for second homes different?
Before the real estate downturn in 2008, homeowners could easily use their home equity – and with very little equity.
But after 2010, mortgage lenders started withdrawing those loose guidelines.
Instead of borrowing up to 100% of the equity of your home with relatively low credit requirements, many lenders have stopped offering home equity loans of any kind for second homes.
Why? Unlike your primary residence, vacation home home loans are a higher risk for lenders.
Your primary residence has the lowest risk when it comes to real estate. The house you live in is most likely the only debt that gets paid, regardless of troubled times.
Vacation homes, on the other hand, are riskier. In troubled times, homeowners are more likely to forego these mortgage payments when money is tight.
In addition, secondary mortgages – including HELOCs and home equity loans – are already considered to be riskier. This is because these loans (after your first mortgage) fall into the “second lien” item, which means that in the event of foreclosure, they may be paid less or not at all.
Given the double risk factors of a second home mortgage, lenders are naturally more reluctant to offer these loans – and they charge higher interest rates in the process.
Don't forget to look around for interest rates
When you buy a vacation home, you can enjoy the financial benefits of owning a property and have a great place to vacation with your family.
Mortgage borrowers will find different lending standards for different types of property depending on their lender and mortgage program. If you can't find a lender who can help, contact a smaller local bank or credit union.
Remember to always buy and compare loan options for your specific needs and financial goals.
Check your new tariff (May 5, 2021)