Home Equity and Investment Properties
One of the benefits of owning a home is building equity in that property over time. Equity is the difference between what your home is currently worth and how much you owe on your mortgage. If your home is worth $460,000 and you owe $200,000 on your mortgage, you have $260,000 in equity.
Having more equity is a positive when you sell. You’ll earn a higher profit.
But you can also borrow against your equity with a home equity loan. You can use the funds from a home equity loan however you want, including to cover the down payment and closing costs on an investment property.
How do home equity loans work?
Most lenders let you borrow up to 80% of your equity in the form of a home equity loan. If you have $260,000 in equity, you can typically take out a home equity loan for a maximum amount of $208,000.
You’ll receive your money as one lump sum. You then repay what you owe, with interest, in regular monthly payments until the loan is fully paid off. This means that you’ll make two mortgage payments a month: one for the mortgage on your primary home and a second for your home equity loan.
You can use the money from a home equity loan on whatever you’d like, including the acquisition costs of an investment property.
Buying an investment property
Though it varies, you’ll typically need to provide a down payment of at least 20% of a home’s purchase price when buying an investment property. For an investment home costing $300,000, that comes out to a down payment of $60,000.
You’ll also have to pay for closing costs on the mortgage for an investment property. This varies but can run from 3% to 6% of your loan amount. If you take out a loan of $240,000, then your closing costs can run from $7,200 to $14,400.
That’s a lot of cash. A home equity loan can give you access to the funds you need to buy an investment property. Depending on the size of your home equity loan, you might be able to provide a bigger down payment that will reduce the size of your mortgage and your monthly payments.
A home equity loan is usually preferable to other funding options, such as taking out a personal loan, because home equity loans typically come with lower interest rates.
There is a risk
Make sure, though, that you can afford to pay your home equity loan payments in addition to whatever other mortgage loan payments you’ll be taking on. If you use a home equity loan to cover down payment and closing costs, you might end up with three total mortgage payments each month: one on your primary home, a second on your investment property and a third to cover your home equity loan.
If you fall behind on any of these payments, your lender can take your home, which depends on which one is connected to the loan you are struggling to pay, through foreclosure. Ensure, then, that your budget can accommodate your new mortgage payments. Work with qualified real estate and financial professionals.
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