How to use a home equity loan to buy a second home

Your home equity could give you the funding you need to purchase a second home.  / Credit: Getty Images/iStockphoto

It’s exciting to purchase a second home. But, it can be difficult for many to afford to do so. After all, making a second home purchase typically requires a significant up-front cash investment. But, it doesn’t have to. You may be able to use the equity you’ve built up in your primary residence to cover the initial cost of your second home.

And the average American homeowner has quite a bit of equity – about $299,000 worth on average. Moreover, those homeowners can tap into an average of $193,000 of that equity while still maintaining a healthy stake in their homes. So, your home equity may provide all the liquidity you need to purchase your second home.

One way to access the value that’s tied up in your home equity is to take out a home equity loan. These loans typically offer lower rates than other popular lending options because they’re backed by your home. And, those rates are typically fixed. In turn, predictable payments may make it easier to budget for the monthly cost of your new purchase. But how exactly do you use a home equity loan to buy a second home?

Find out how much home equity you could use toward the purchase of a new home now.

How to use a home equity loan to buy a second home

When you use a home equity loan to buy a second home, “you gain access to capital without selling off assets, leverage your investments for potentially higher returns, and diversify your portfolio with real estate assets,” explains Dutch Mendenhall, founder of the alternative investments firm, RAD diversified. Follow the steps below to get started.

Step #1: Determine your budget for your second home

The average home in the United States is worth about $344,000. But that doesn’t mean you can expect the price of your second home to be exactly that number. Home prices vary depending on a wide range of factors like location, the size of the home, amenities, the size of the lot the home sits on and more. Think about the location where you want to buy your second property and other factors that may impact its price. Then create a reasonable budget for your purchase.

Compare leading home equity loan options now.

Step #2: Determine how much home equity you need to tap into

In order to determine how much home equity you’ll need for your purchase, calculate reasonable down payment and closing cost expectations based on the budget you came to. Keep in mind that a typical down payment is around 20% of the cost of the home and closing costs can be as high as 6% of the cost of the home.

So, say your budget for your second home is $300,000. You’ll likely need up to $78,000 in available funding to cover the initial costs of the purchase – $60,000 for the down payment and $18,000 for the closing costs.

Next, consider how much money you already have toward the purchase of your second home. If you already have $20,000, you’ll then need a home equity loan for the remaining $58,000 of the above costs.

Step #3: Apply for a home equity loan

Next, compare your home equity loan options and apply for the one you believe fits best in your situation. When you apply for the loan, consider requesting a little more money than you need to purchase your second home in case any surprise expenses arise.

And when you receive the money, look for ways to earn a reasonable return on it while you go through the rest of the steps below. A high-yield savings account can help.

Step #4: Go house shopping and make an offer

Next, go on a house hunt. When you find a second home that meets your needs, make an offer. If the offer is accepted, move onto the next step.

Step #5: Apply for a mortgage on your second home

Now that you have an accepted offer and agreed upon price, it’s time to apply for the mortgage. Keep in mind that lenders set their own interest rates, fees and terms. So, you’ll want to find one with a reasonable interest rate, low fees and terms you can afford.

Step #6: Close on your second home

When it’s time to close on your home, use the money you’ve saved in combination with the home equity loan you took out to purchase your second home.

Use a home equity loan to cover the initial cost of your second home purchase now.

The bottom line

It’s relatively simple to use a home equity loan for the purchase of your second home. And since the average American homeowner has such a high amount of available equity right nows, it’s a viable option for many Americans. Follow the steps above to use a home equity loan to purchase your second home now.