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Looking to buy a vacation home or rental property? A home equity line of credit (HELOC) lets you leverage the equity in your primary residence to help buy a second home. Already have a second home and wondering, can you use a HELOC to buy another house or other property? That’s another important question.
Before pursuing HELOC financing involving a second home, it’s important to understand HELOC borrowing limits, repayment structure, and lender requirements. Here’s a closer look at how a home equity line of credit on a second home works.
Key Points
• Borrowers can typically secure a HELOC on a second home if they possess at least 20% equity and meet the lender’s credit and debt-to-income requirements.
• A HELOC offers flexible funding that can be used for various purposes, such as covering the down payment on another property or financing home renovations.
• Key HELOC benefits include the option for interest-only payments during the draw period and potentially lower closing costs than a traditional mortgage.
• Possible risks include the chance of foreclosure if payments are not maintained and exposure to variable interest rates.
• HELOC interest is generally not tax deductible unless the funds are reinvested into the home securing the loan.
Can You Get a HELOC on a Second Home?
Borrowers who already own a second home may be able to get a HELOC on a second home or primary residence. Qualifying for a HELOC, which is technically a second mortgage, comes down in part to how much equity you have in a property. You typically need to have at least 20% equity in your second home to secure a HELOC. Home equity is the difference between the value of your home and the remaining mortgage principal balance.
The amount you can borrow with a HELOC is typically capped at 85% of your home’s value, minus whatever you owe on your mortgage. However, lenders tend to view a HELOC on a second home as higher risk, so there may be lower borrowing limits and higher interest rates.
Qualifying for a HELOC also usually involves a home appraisal to determine the home value. Lenders also consider the borrower’s credit score, mortgage payment history, and debt-to-income ratio.
Recommended: What Is a HELOC?
HELOC on a Second Home vs Primary Residence
Taking a HELOC out on a second home vs. primary residence carries potential tax implications for borrowers depending on how the funding is used.
As with a mortgage, the interest you pay on a HELOC can be tax deductible. But not all uses of funds qualify for a HELOC tax deduction. You can deduct the interest paid on a HELOC only if the funds go toward buying, building, or improving the property used to secure the financing. Connect with a tax advisor about this or any tax matter, so you can obtain advice tailored to your specific situation.
In other words, interest payments would not be tax deductible if the HELOC is used to buy a second home. However, a HELOC on either a primary residence or second home could qualify for tax deductions if the funds are invested in that same property.
Can You Use a HELOC to Buy a Second Home?
A home equity line of credit is a versatile financing option that can be used for a variety of reasons. If you’re wondering, Can I use a HELOC to buy another house?, the short answer is yes.
Buying a second home with no down payment is rare, so the flexible funding offered by a HELOC can provide the necessary cash to close on a second home.
Thinking about taking out a HELOC to purchase a second home? Here are some potential benefits and drawbacks of using a HELOC to buy second homes.
Pros of Using a HELOC to Buy Another House
There are many reasons people tap into home equity. Using a HELOC to buy a second home can present some advantages for homebuyers.
• Flexible funding: Borrowers have lots of discretion on how money is spent, from using a HELOC for a down payment to covering renovation costs or unplanned expenses.
• Interest-only payments during the draw period: You’ll pay interest only on the amount you’ve taken out during the draw period (typically 3 to 10 years) rather than the full credit line that’s available to you. Payments on the principal are typically not due until after the draw period ends.
• Lower interest rate: HELOCs tend to offer more competitive interest rates than personal loans and credit cards because they are secured with a property.
• Lower closing costs: Borrowers tend to pay less in closing costs on a HELOC than on a conventional mortgage.
• Keep your primary mortgage intact: Taking out a HELOC doesn’t impact the interest rate or monthly payment on a borrower’s primary mortgage like a cash-out refinance. “There are specific times when it may make sense to refinance a mortgage. When considering whether a refinance is a good idea, think about the closing costs and calculate how long it would take to recoup them,” says Brian Walsh, CFP® and Head of Advice & Planning at SoFi.
Recommended: Personal Loan vs. Personal Line of Credit vs. Home Equity Line of Credit (HELOC)
Cons of Using a HELOC to Buy Another House
On the other hand, HELOCs have some potential downsides to keep in mind when considering your financing options for an investment property or second home.
• Foreclosure risk: HELOCs are secured by a property, so borrowers risk losing their home if they fail to keep up with monthly payments.
• Not tax deductible: HELOC interest payments would not qualify for a tax deduction if the funds are used to buy another house. Interest is tax deductible only if the money is put toward the improvement of the property used to secure the financing.
• Less predictable monthly payments: HELOCs typically have variable interest rates that are tied to the prime rate, which fluctuates over time. Plus, HELOC payments increase as more money is withdrawn.
• Multiple repayment periods: Once the draw period ends, HELOCs enter the repayment period when monthly payments include both interest and principal.
Recommended: Can You Get a HELOC on an Investment Property?
How to Use a HELOC to Buy a Second Home
Here are some steps to use a HELOC on a second home purchase.
Determining how much you can borrow with a HELOC is a useful place to start. First, calculate your home equity by subtracting the remaining mortgage principal from your home’s current value.
Home Value – Mortgage Balance = Home Equity
For example, if you have a $600,000 home and $200,000 left on your mortgage, you have $400,000 in home equity. Plug in your own values using the formula above.
Next, calculate the combined loan-to-value (LTV) ratio for your primary mortgage and the HELOC. Lenders use this to assess risk and a lower LTV typically translates to more favorable interest rates and loan terms. Borrowers generally need a combined LTV ratio of 85% or less to qualify.
(Mortgage Balance + HELOC) Ă· Home Value x 100 = Combined Loan-to-Value Ratio
Using the scenario above, a borrower with a $600,000 home could have a maximum combined value of $510,000 ($600,000 x 85% = $510,000) for their primary mortgage and HELOC. So with a $200,000 mortgage balance, the maximum HELOC would be $310,000.
Recommended: How Much Can You Borrow From Your Home Equity?
Alternatives to a HELOC for Buying a Second Home
A HELOC isn’t the only option to tap into your home equity. Homeowners can also consider a home equity loan to purchase a second home for more predictable monthly payments.
Like a HELOC, home equity loans are secured by a property, which means there’s a risk of foreclosure if you’re unable to make payments. But home equity loans differ in several ways. For one, they’re disbursed at once as a lump sum. They usually have a fixed interest rate vs. a variable interest rate that’s common with HELOCs.
Borrowers who know exactly how much funding they need may prefer a home equity loan. But if your budget is less certain, the flexibility of a HELOC could be advantageous.
The Takeaway
Can you use a HELOC to buy another house? Possibly. Homeowners can often leverage their home equity to fund the purchase of a second home. Whether buying an investment property or vacation home, the flexibility of a HELOC and initial interest-only payments could be helpful when navigating uncertain budgets.
Can you take out a HELOC against a second home? Yes, you can — though your borrowing limit may be lower than for your primary residence.
Alternatively, borrowers may prefer a home equity loan for fixed monthly payments over the loan term.
SoFi now offers flexible HELOC options to turn your home equity into cash. Access up to 85% of your home equity, or $750,000, to finance home improvements or consolidate debt. Competitive interest rates and repayment terms up to 20 years could result in lower monthly payments versus other loans. And the online application process is quick and convenient.
FAQ
What credit score do you need for a HELOC on a second home?
You usually need a minimum credit score between 620 and 680 to qualify for a HELOC. Lender requirements may be more strict if you are taking out equity from your second home to fund another property purchase.
Can you use a HELOC on a second home to buy an investment property?
You can use a HELOC on a second home to buy an investment property. Keep in mind that interest paid on a HELOC is tax deductible only if funds are put toward the property used to secure the line of credit. Talk to a tax advisor about the full tax picture of investing in real estate, particularly if this is your first investment property.
How much equity do you need to get a HELOC on a second home?
Borrowers typically need at least 15% home equity to get a HELOC on a second home. How much you can borrow also depends on the combined loan-to-value ratio of your primary mortgage and the HELOC.
Is the interest on a HELOC for a second home tax deductible?
The interest on a HELOC for a second home is tax deductible only if the money you borrow is reinvested back into that property. Some eligible improvements might include replacing a roof, remodeling a kitchen, or building an addition.
What is the maximum LTV for a HELOC on a second home?
The maximum LTV for a HELOC on a second home is often more strict than for a primary mortgage. Whereas a LTV ratio of 85% or even 90% may be possible for a HELOC on a primary mortgage, a LTV ratio may be capped at 80% or less for a HELOC on a second home.
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