Using the Home Equity for Investing in a Second Home
A common issue among homeowners is the dilemma on using existing home equity for investing on a second home. Because of the relatively low interest rates, the real estate market continues to draw the attention of new investors. Many are considering buying a new home as an asset. However, the liability of taking out a new mortgage loan remains a major obstacle. Moderate investors really cannot afford to buy the property in cash. Taking out a new loan seems the only option.
It’s not that there are no other options. Many investors consider selling some bonds and stocks for raising the required amount. Some even consider other high-risk propositions like taking out the amount from the IRA or a taking out a 401(k) loan. Truth is, any proposition in new homes is risky, considering the size of the investment. Real market conditions can be very transitory. The memory of the bubble and the subsequent crash leading to the acute depression is still fresh in the subconscious. Therefore, if you are considering buying a new home on the equity of the existing property, always make sure to consider the various aspects of the deal. Try to interpret the present trends with a futuristic outlook to understand the direction of the market. This can give you greater confidence than before to buy a new home.
The home equity is essentially the illiquid amount difference between the mortgage debt and the market value of the home. So, a home that is worth $400,000 in the market and has a mortgage debt of $300,000, has a home equity of $100,000. If home prices rise, the home equity also increases. The liquidation of the liquid amount is possible through a loan on home equity or through a line-of-credit on it. Another name of the line-of-credit is the cash-out refinancing. This indicates that you can take a new loan with greater balance that is useful in clearing the existing mortgage, and in using the remaining amount to buy a new home. However, this does not get rid of the debt, as you still have to repay the new loan.
Using the home equity value to buy a new home has both pros and cons of the process, according to senior financial analyst, Greg McBride. Lenders like banks allow for greater flexibility in the loan terms because the homeowner is already one-home deep in the market. The homeowners taking out a second mortgage are more likely to default than those using home equity values to take out a loan. In order to offset the risks, the banks charge higher interest rates and bigger down payments. Besides, the home equity loans do not include paying for the insurance or title charges or any other extra transactional costs of taking out a new mortgage.
However, there are some negative aspects of a home equity loans also. A new loan entails greater
responsibilities. Besides, taking out a home equity loan also makes the existing property more vulnerable than before. Understandably, new investors are afraid about losing both homes for debt defaulting. The home equity loan also entails tying up the money in a single asset. This may not be a very prudent portfolio management, clarifies McBride.