You can use home equity to buy another house, and homeowners do it routinely through one of three tools: a home equity line of credit (HELOC), a home equity loan, or a cash-out refinance. Each converts part of the value stored in your current home into cash you can put toward a down payment or the full purchase price of the next property. Whether it’s a smart move depends on how much equity you actually hold, your credit and income, whether the second property will be a vacation home or a rental, and your tolerance for putting your primary residence on the line as collateral.
Your equity is the gap between what your home is worth and what you still owe. A house valued at $500,000 with a $300,000 mortgage balance holds $200,000 in equity. Lenders let you borrow against a portion of that figure, not all of it.
The Three Ways to Tap Equity for a Second Property
Home Equity Line of Credit
A HELOC is a revolving credit line secured by your home. You draw funds as needed during a set period, typically ten years, and the lender records a subordinate lien so your original mortgage keeps first-priority repayment status.1Fannie Mae. First Lien Delivered with Subordinate Financing Rates are variable, so your payment can change over time. The flexibility suits buyers who aren’t sure of the exact purchase price yet or who want to draw funds in stages.
Home Equity Loan
A home equity loan hands you a single lump sum at a fixed rate, repaid in equal installments. Like a HELOC, it sits in second position behind your primary mortgage.1Fannie Mae. First Lien Delivered with Subordinate Financing The fixed payment makes budgeting straightforward when you know the down payment amount you need.
Cash-Out Refinance
A cash-out refinance replaces your existing mortgage with a new, larger one and pays you the difference. You end up with a single first-priority lien and no second mortgage. The trade-off is that you’re resetting the rate and term on your entire balance, and closing costs run higher because you’re refinancing the whole loan rather than just the borrowed portion. This route makes the most sense when current rates would improve on what you’re already paying.
What You Need to Qualify
Lenders test the same benchmarks whichever product you choose. Meeting them shows you can carry the added debt without endangering your primary home.
- Combined loan-to-value ratio (CLTV). Your total mortgage debt after the new borrowing generally can’t exceed a set share of your home’s appraised value. For a second home, Fannie Mae allows up to 90 percent CLTV on a single-unit property; investment property purchases cap at 85 percent for one unit and 75 percent for two-to-four units.2Fannie Mae. Eligibility Matrix
- Credit score. Fannie Mae’s minimum for conventional loans is 620, though scores of 700 and above tend to earn materially better rates.3Fannie Mae. General Requirements for Credit Scores
- Debt-to-income ratio (DTI). Fannie Mae’s automated underwriting allows DTI up to 50 percent; manually underwritten loans cap at 45 percent with compensating factors. The projected payment on the new borrowing counts against this number.4Fannie Mae. Debt-to-Income Ratios
- Cash reserves. You’ll need money left over after closing. Fannie Mae requires at least two months of reserves for a second-home purchase and six months for an investment property. If you own additional financed properties, you’ll hold extra reserves equal to 2 percent of the combined unpaid balance on those mortgages, rising to 4 percent for five to six financed properties and 6 percent for seven to ten.5Fannie Mae. Minimum Reserve Requirements
Second Home or Investment Property: The Classification Matters
A second home is a property you plan to occupy for part of the year. An investment property is one you buy mainly to rent out. The classification changes almost every number on the application.
Investment properties require a larger down payment, higher reserves, and often carry a higher interest rate. The maximum CLTV on a one-unit investment purchase is 85 percent, compared to 90 percent for a second home.2Fannie Mae. Eligibility Matrix Reserve requirements run three times higher.5Fannie Mae. Minimum Reserve Requirements
Don’t try to game this. Claiming a rental will be a vacation home to get better terms is occupancy fraud. Under federal law, a false statement on a mortgage application can carry fines up to $1,000,000 and up to 30 years in prison.6Office of the Law Revision Counsel. 18 U.S. Code 1014 – Loan and Credit Applications Generally Criminal prosecution of individual borrowers is uncommon in practice, but a lender who discovers the misrepresentation can call the full loan balance due immediately, and failing to pay leads to foreclosure.
The Tax Trap: Interest May Not Be Deductible
This is the detail most buyers miss. Interest on a home equity loan or HELOC is deductible only when the borrowed funds are used to buy, build, or substantially improve the home that secures the loan.7IRS. Publication 936 – Home Mortgage Interest Deduction
Read that again in the context of what you’re doing. If you take a HELOC against your primary home and spend the money on a different house, the interest on the HELOC generally isn’t deductible, because the funds weren’t used to improve the home that secures the HELOC. The same reasoning applies to the cash-out portion of a refinance used to buy a separate property.
The workaround is a purchase mortgage taken directly on the second property. That interest can qualify as deductible acquisition indebtedness, subject to a combined cap of $750,000 in mortgage debt across your primary and second home ($375,000 if married filing separately) for loans taken out after December 15, 2017.8Office of the Law Revision Counsel. 26 U.S. Code 163 – Interest Older loans follow the earlier $1,000,000 limit.7IRS. Publication 936 – Home Mortgage Interest Deduction A second property used exclusively as a rental isn’t a qualified residence at all; separate rules govern rental property interest.
The Risks You Are Taking On
Your Primary Home Is the Collateral
A HELOC or home equity loan creates a second lien on the house you live in. Default on that obligation and the second-lien holder can initiate foreclosure, even if you’re current on your first mortgage. The first mortgage still gets paid first from sale proceeds, but the sale itself happens. A relatively small equity loan can cost you the house.
Overleverage in a Downturn
If values drop, you can end up owing more than either property is worth. Carrying an equity loan plus a mortgage on a second property multiplies the exposure, and it narrows your options if you need to sell your way out.
Cross-Collateralization
Some loan agreements let the same collateral secure more than one loan. If your equity lender includes such a clause, you may not be able to sell or refinance your primary home until every loan tied to it is paid off, including loans you thought were independent. Ask the lender directly whether the agreement contains a cross-collateralization clause, and read the document before signing.
Variable Rate Exposure
HELOC payments move with interest rates. If you’re already stretched across two properties, a rate increase can push your DTI past a comfortable level. A fixed-rate home equity loan removes that risk but locks in the payment if rates later fall.
Costs and Timing
Closing costs on a HELOC or home equity loan generally run 2 to 5 percent of the loan amount, covering the appraisal, title work, and origination. Some lenders waive costs on smaller equity products, so shop around. A cash-out refinance is more expensive at closing because you’re refinancing the entire balance.
For a HELOC, plan on roughly 30 days from application to closing. Cash-out refinances typically take longer.
One consumer protection to know about: if the loan is secured by your primary residence, federal law gives you three business days after closing to cancel for any reason at no cost.9eCFR. 12 CFR 1026.23 – Right of Rescission On a cash-out refinance of your primary home, this right of rescission covers only the new money beyond your existing balance, not the refinanced portion.10Consumer Financial Protection Bureau. 1026.23 Right of Rescission The rescission right does not apply to the purchase mortgage on the new property itself. Once the rescission window closes on the equity borrowing, funds are typically wired to the closing agent handling the second-home purchase.