Hello World! Welcome Friends! You might be one of those homeowners who nurture a dream of owning a vacation or a second home. Owning a second home can couple up as a source of regular rental income.
However, the primary challenge would be obtaining a mortgage to purchase one. With stringent norms blocking your ambitious goals, you have a simpler alternative to tap. The equity of your current residence can help you purchase another house to rent out.
Now, you would be wondering how you can purchase a second home through a home equity loan. Of course, it’s possible to use your home equity while making the purchase. In this post, the professionals will inform you about home equity loans and how you can use them for purchasing a property.
What Is A Home Equity Loan?
Simply put, a home equity loan refers to a kind of second property mortgage. Through this loan, you can gain access to the equity in your current home and utilize its value. Home equity refers to the difference between the value of your home and your liabilities to the lenders. This is actually the value that you are owning.
As you keep paying the mortgage payments, the loan balance gets reduced. In the process, you keep on building your equity. When you obtain a home equity loan, you receive an amount in the form of a lump sum payment. Next, you need to pay this amount back to the creditor in the form of fixed installments over a period of time.
Difference Between Investment Properties And Home Equity Loans To Purchase A Rental Property
In case you’re planning to bank on your home equity for purchasing a new home, you need to consider one serious aspect–whether you are purchasing this property as an investment property, or as a second home.
It is crucial to consider this aspect, as it would impact your capacity to obtain funding. Have a look at the prime difference between channelizing your home equity for an investment property and a second home.
- An investment property would help you pay off the obligation by generating a consistent flow of rental income. However, you won’t have this financial support in case you use it for personal purposes.
- Individuals are more likely to afford investment properties when they utilize their home equity, rather than a second home.
How Can You Purchase A Rental Home Using Home Equity?
You have several methods for cashing out the home equity. Depending on your financial strength and other aspects, you need to choose the right one. Have a look at the different means of cashing out a home equity loan.
- Home Equity Line of Credit (HELOC)
- Second Mortgage
- Cash-Out Refinance
- Reverse Mortgage
Home Equity Line of Credit (HELOC)
A home equity line of credit refers to an open-ended line of credit for the equity in your current residence. This works like a credit card, where you can borrow funds and repay the same, while the line stays constantly open.
In these systems, you would have an initial draw period, which is determined at the beginning of the loan. The loan period in this case is completely amortizing.
In case you are interested in flipping your property, this would be the best option. In the process, you can purchase the home, make payment for renovations, and also repay the debt after selling off the property.
Second Mortgage
Second mortgage refers to a home equity loan at a fixed interest rate, where you can obtain lump-sum payments at pre-set repayment conditions. By the end of the term of your loan, second mortgages get fully repaid.
However, there are other types of second mortgages, like balloon payments and interest-only home equity loans. In such cases, the fee structure is similar to HELOCs but the repayment schedules are more transparent.
Cash-Out Refinance
With a cash-out refinance, you can refinance the balance mortgage at the interest rate prevailing in the market. You can also rewrite the loan balance for a greater amount.
Additionally, you can draw cash at a lower rate against your property and get a consolidated first lien mortgage on a singular property. Moreover, you can benefit from the additional lump-sum payment when you close it.
Reverse Mortgage
This is an arrangement where a homeowner can tap the equity either as a line of credit or as a lump sum amount. Besides, you need not repay the amount unless you leave this property.
Compared to traditional mortgages, the fees associated with reverse mortgages are generally higher. Besides, you can enjoy a greater degree of flexibility when it comes to monthly cash flows.
In case you own a rental home, this would be ideal for making a down payment, as you won’t require any cash outflow at the beginning.
Benefits Of Using Your Home Equity To Purchase A Rental Property
In case you’re planning to purchase a rental property, obtaining a home equity loan would make the purchase less expensive.
The buyer, in this case, would enjoy a greater degree of liquidity. Here are some of the advantages of using home equity to purchase an investment property.
1. Make A Greater Down Payment
As a homeowner, you would be receiving your home equity loan as a lump sum payment. This would provide you with more cash to make the down payment for the next property.
This implies that you would have lower monthly payments to make in the form of installments. Moreover, making a larger down payment reduces the interest rates significantly.
2. Resolve Your Financial Challenges
Purchasing a second home may turn out to be challenging, considering the stringent requirements for down payments. However, a home equity loan would make this purchase more affordable.
3. Enjoy Lower Interest Rates
As stated above, a larger down payment would lower the interest rate on your second home. While you would be earning rental income from the property, you would also gain by shelling out low rates of interest on the same.
The reason for this reduced interest rate is that these loans are secured by real estate. This implies that you can dodge high interest rates that you would have to fork out had you taken a personal loan or hard money.
Endnote
Although home equity loans serve as a perfect mechanism through which you can purchase a second property for rental purposes, it might be challenging to obtain the credit.
Once you reach out to the right creditors, you would enjoy a seamless financial experience. Don’t shy away from a professional consultation regarding your finances as this will ensure that you make the right decisions.
Click the links below for any posts you have missed:
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