Whether you’re looking to buy a second home to use as a vacation property or a rental property, a new home purchase is often a smart investment. Here’s how to use a home equity loan to buy a second home.
Home Equity Loans Explained
Home equity is the amount of your home you own outright—the value of your home over and above any debt that you owe on the home. You can find this amount by subtracting the balance of your mortgage and any other loans on your home from its appraised value. Lenders typically allow homeowners to borrow up to 85 percent of their home’s equity.
There are two main types of home equity loans: a home equity loan and a home equity line of credit (HELOC). A home equity loan functions similarly to your first mortgage. A line of credit functions more like a credit card.
With both home equity loan options, you access the equity you’ve built up in your current home, using the home itself as collateral. That money can then be used as you wish: in this case, to finance the purchase of your second home. For both types of loans, repayment is separate from your current mortgage, so you will now have two payments each month.
How Home Equity Loans Work
Just like your original mortgage, a home equity loan is taken out as a single lump sum. You can spend all the money at once or save some of it to use later, but it has officially been borrowed. This means the loan will start accruing interest immediately, and you will be required to make monthly payments right away.
You have the option of choosing either a fixed-rate or adjustable-rate home loan. With a fixed-rate loan, your monthly loan payment will be the same throughout the term of your loan. Capital Credit Union offers 5-year, 7-year, and 10-year fixed-rate home loans at competitive interest rates.
You also have the option of closing on an adjustable-rate home equity loan. When your rate is adjustable, your interest rate shifts over time. Adjustable rates are usually lower than fixed rates at the beginning of the loan term. But after that introductory period, the rate will adjust based on market conditions, and your loan payments will vary over time. Some months the payments may be lower, others they may be higher.
How HELOCs Work
A home equity line of credit usually has a draw period and a repayment period. During the draw period, the HELOC functions similarly to a credit card. You can draw on the line when you need it, pay back the balance in part or in full, and then draw on the available funds again. You can repeat this process as often as you’d like during the draw period. This period typically lasts up to 10 years.
During the draw period, you are only responsible for paying the interest on your outstanding balance. This means you will not owe any amount toward the principal balance until the repayment period begins. Once the repayment period kicks in, you’ll be responsible for paying back any principal balance plus interest. Repayment periods usually last up to 20 years and interest is usually at an adjustable rate.
Which Type of Home Equity Loan is Right for You?
The answer to this question depends on what you want out of your home loan. For instance, if you’re concerned about being able to afford two mortgage payments initially, you may want to opt for the flexibility a HELOC provides.
If you’re set to pay off your first mortgage in a few short years and the repayment period for a HELOC doesn’t start for 10 years, you can pay off your first mortgage and be in a better financial position by the time you start paying back the principal balance on your second mortgage. Likewise, if you want to have the option of drawing on the available funds multiple times—as you might if you decide to use some of the money to make home improvements—you may want to opt for a HELOC over a home equity loan.
On the other hand, if you want to start paying on the loan right away and would prefer fixed monthly payments, a fixed-rate home loan would likely be the preferable option. Or perhaps you expect to pay the loan back quickly. In this case, an adjustable-rate loan that offers a lower interest rate initially may be the best choice.
The smart thing to do is review all your options with your financial advisor or local credit union representative. They can walk you through the nuances of each loan type so you can decide which one is the best for your particular situation.
How to Apply for a Home Equity Loan
Once you’ve settled on the home equity loan that’s right for you, you’re ready to apply. If you’re looking to close on a northeast Wisconsin home equity loan, Capital Credit Union is here to help. Our home loan application is quick and easy. You can complete your application online or in person at one of our branch locations.
Using a home equity loan to close on a second home allows you to put your existing collateral to good use by expanding your real estate portfolio. Expanding your ownership in real property can help you increase your net worth. You can rent out your property as an additional source of income or simply use it as a home away from home when you need a few days of vacation.
If you’re in the market for a second home, Capital Credit Union is ready to help you make your purchase as quickly as possible. Simply schedule an appointment with one of our home loan specialists, and you’ll be closing on your second home in no time at all.
Capital Credit Union is an Equal Housing Opportunity Lender.