As a homeowner who makes mortgage payments every month, you might be interested in refinancing your house to purchase a second home. This new purchase could be for a fun vacation spot for the family or new investment property. Regardless of the reasons, refinancing might be for you.
What We'll Cover
If you think that refinancing might be a good choice to help buy that second dream home, learning what refinancing involves and who you should refinance with are the first steps to making this massive financial decision work for you. Continue reading to learn how to refinance your mortgage to buy another house.
What Does Financing Entail?
When you bought your first home, you probably put some money down, paid the closing costs, and then started paying your mortgage payments to your chosen lender in order to live in your new home. But, what if down the road you decide you want to purchase a second home? Can you refinance the first to help finance the second?
The answer is yes, but there are some caveats.
- You need to have a solid amount of equity in your home.
- Your credit also needs to be high enough to lock in worthwhile interest rates on both homes.
- If you decide to refinance your mortgage to buy another house, you essentially get a brand new mortgage for your original home.
The refinanced mortgage will pay off the balance of your old home loan, and then you will begin paying a new monthly mortgage rate. The bonus of this refinancing is that you can also leave the table with a substantial amount of cash in your pocket. Refinancing can be a lucrative way to receive the money needed to purchase a second home.
There are three recommended ways to refinance your mortgage to purchase a second home. The first is called cash-out refinance, which allows you to attain a brand new mortgage on your home and cash in your pocket. The other two are a HELOC (formally called a Home Equity Line Of Credit) and a home equity loan.
Is It Easier to Refinance with My Current Lender?
Before you choose what type of home loan works best, however, you need to decide whether you should refinance with your current lender or move to a new one. At first glance, using your current lender may seem like the least complicated option.
It could save the aggravation of completing extra paperwork with a new lender, resubmitting financial documents, and having to learn a new repayment system through a new Website. However, the simplest option is not always the most beneficial one.
Taking the time to research different financing companies to get the best refinancing rate will save thousands of dollars down the road. Your current lender may want to keep you as a valued customer and reward you with a persuasive interest rate. They may also reduce or even waive your closing costs so that they do not lose your business.
Do Your Research
The best route in refinancing is to do your research and compare the upfront costs of refinancing and the current interest rates offered by each financial institution. By taking the time to get numerous quotes from many different lenders, you will ensure you are getting the best refinancing choice possible.
The first step is choosing whether you will stay with your current lender or take your business elsewhere. After you do that, you will then need to decide which type of refinancing is best for you. The three choices discussed here have pros and cons and depend on the homeowner’s current needs.
All three can work when refinancing a current home to purchase a second one and will give a homeowner the money needed to purchase a second home. However, they will only be lucrative if there is enough equity built up in the original home since this home is essentially used as collateral to get the cash.
Option 1 – Cash-Out Refinance
When you use the cash-out refinancing option you no longer have your original loan. Instead, you get a brand new one with whomever you are working with for this option. The key here is how much equity you have in your home, as the new mortgage (and the cash back) will depend on that number.
This option is worthwhile when refinancing an existing home because you can receive the money needed for a down payment on a second home at closing. Just make sure your home’s equity has increased since you bought the home. If you have lived in your home long enough to have built up equity, this choice is a great option for refinancing.
Let’s say you purchased a home for $200,000 fifteen years ago and now it appraised at $350,000. Since the equity in your home has increased, you are able to pay off your current mortgage through the cash-out refinance option, and get money to pay the upfront costs of a second home. You are taking advantage of the equity built up over those fifteen years.
How a Cash-Out Refinance Works
With this option, a few things will happen, completely changing the way your mortgage works:
- The new mortgage will replace the old one
- The equity in the old mortgage essentially disappears
- The homeowner begins paying the monthly payments and interest fresh on a new loan
You can get a loan that equals up to around 80% of your house’s current equity by doing a cash-out refinance.
You will need to have someone come out and appraise your home. Then, if your primary home’s value went up substantively, you could get a pretty large chunk of change. As soon as the mortgage closes on your primary home and any outside costs are paid, which comes out of the cash you receive, the remaining cash is yours to spend.
As with the example above, if you originally received a home loan for $200,000 and the appraised value of your home increased to $300,000, you would now have $150,000 in equity. Therefore, you can refinance for the new loan up to 80% of that equity, which can be a very lucrative down payment for your second home.
The Pros and Cons of Cash-Out Refinance
Having a large amount of cash will help pay for the new home’s upfront costs, such as the down payment and closing costs. However, you should try to make sure the new loan on your first home has a lower interest rate since you increased the amount of that original mortgage.
- Getting a large sum of cash to help purchase your second home
- The interest rate could be lower than the one on your original mortgage
- You can deduct the interest paid on the money used to purchase the new property
- Saving some of the cash to make home improvements on your first home
- Using any leftover cash to pay down any debt so that paying two mortgages is more manageable
- The homeowner loses all of the equity built up in the original mortgage
- Extending your mortgage payments on the original home – sometimes for decades – since you essentially received a brand new mortgage
- Added costs involved, such as possibly reestablishing private mortgage insurance and closing costs, may reduce the lump sum payment of cash
- Possibly increasing your original interest rate
- As with any new mortgage, there are fees and closing costs involved
The cash-out refinance option pays off the old mortgage, replaces it with a new one, and allows the homeowner to withdraw the equity in cash. This might be a chance to lower the original interest rate, but the homeowner will pay more interest over time because the loan is extended.
A HELOC and a Home Equity Loan
If the cash-out refinance option seems too complicated, you may want to research a HELOC and a home equity loan. Both of these options could be more attractive than the cash-out refinance alternative because the homeowner can take out a higher loan-to-value percentage on their primary home (85% to 90%).
There are also some downfalls to both, however, depending on your current situation. On the one hand, a HELOC is a line of credit that stays open for a period of time and has variable rates. The money can be taken out at any time, but a variable rate could increase monthly payments over time.
On the other hand, the more standard option is a home equity loan. This option is less complicated because the homeowner receives a set amount of money and a fixed interest rate. Just be aware that, although the interest is fixed, it may also be higher than the other two options. That is why it is important to take a look at every option.
Option 2 – HELOC
A HELOC is similar to the other two options in that the amount depends on the equity you have built over time in your house. This option works much like a credit card.
When you open a HELOC, you:
- Can borrow funds from the open line of credit
- Use that money to pay the upfront costs involved in purchasing your second home
- Repay the line of credit at a later date
A HELOC can be a rewarding option to have a line of credit stay open and allow for available funds over a period of time. You can then withdraw the funds when you need the money. The interest rates may change, however, which will change the money owed each month on the existing loan.
You should keep in mind that variable interest rates may also climb sharply over time. Consider this when you think about opening a credit line through a HELOC.
HELOC – Advantages and Disadvantages
Using home equity as a line of credit may be a great option, but it has its own advantages and disadvantages, just like the other two options.
- A line of credit that works similar to a credit card, except it is dependent on the equity you have in your home
- The homeowner pays lower fees and closing costs because this option takes less time to complete
- Lenders may cover the closing costs on the new home purchase
- The interest paid on a HELOC cannot be deducted on one’s taxes for the purchase of a new home, only for buying or improving the existing loan put up as collateral
- A HELOC does not give the homeowner a large amount of cash upfront, and the interest rate may be higher than the first mortgage
- Interest rates are variable and can increase over time
Unlike opening a line of credit that stays open for a period of time, a home equity loan is much simpler because it mirrors a standard mortgage loan you would get from a bank. The home equity loan option gives the homeowner a fixed interest rate, which means a fixed monthly payment with no surprises.
Option 3 – The Home Equity Loan
The third option to refinancing a home to purchase a second home is a standard home equity loan. This option is similar to the cash-out refinance and HELOC choices, as you use your home’s increased equity to purchase your second property. It is also a low-cost option upfront and is the least complicated way to fund this new investment.
Similar to the cash-out refinance option, the homeowner will receive a fixed number of monies and a fixed interest rate. That is, the bank may say, “we will give you a $400,000 loan at 2% interest.” This fixed interest rate helps the homeowner plan for expenses because the monthly mortgage payment never changes.
This fixed rate might be tempting, but these interest rates are usually higher than cash-out refinancing or HELOCs. In addition, home equity loans usually have shorter terms of repayment than an average mortgage, making the monthly payments much larger over time.
Advantages and Disadvantages of a Home Equity Loan
Home equity loans are attractive because they are simple – they allow for a fixed mortgage and fixed rate and provide some benefits, but it also has some disadvantages that should be considered.
- Having an interest rate is fixed means you do not have to worry about fluctuating interest
- The money comes in one lump sum, which can give you options, especially when paying for bigger expenses
- The homeowner pays lower fees and closing costs upfront because this option takes less time for the lender to complete
- This option usually offers lower interest rates
- The interest rates are usually higher than cash-out refinance or HELOCs
- The payoff time is usually shorter than traditional mortgages, making the monthly mortgage payment larger
- Unlike a cash-refinance loan, you cannot deduct the interest from a home equity loan on your taxes when you purchase of a new home, only for buying or improving the existing loan put up as collateralIt may take a long time to rebuild the equity used to purchase the second home
- Property values may change over time, making it difficult for the homeowner to repay the debt on both properties
This option is normally more beneficial for home improvements on an existing property, so that should be considered.
When Is Refinancing and Purchasing a New Home Not a Good Idea?
Just because you can refinance your primary home and then use the available cash to purchase a second home does not mean you should. There are many issues that need to be considered when refinancing a new home just for home improvements or a lower interest rate.
Things are that much more complicated when you are refinancing for a second home purchase. For example, many refinancing options will have a clause that the homeowner must stay in the original home for at least a year. So, if you are planning on selling the first home any time soon, be sure to read the fine print.
Most lenders will not allow you to refinance your first home, purchase the second home, and immediately sell the first house and move into the second. That means you will be paying on two mortgages for at least a year.
Will I Need More Money Down?
The underwriting will also be more difficult on the second mortgage. In many cases, lenders may request a higher down payment – as much as 6 times the rate of the down payment on a primary residence. According to Forbes, buyers usually put around 20% down.
What does that mean in real terms? If you put a 3% down payment on a $300,000 home, the cash you would need at closing is $9,000. How does that change if the lender requires 20% down? You would now need a whopping $60,000 down at closing!
If you cannot afford the $51,000 difference, you may need to reconsider refinancing your first home to purchase a second.
Where Do I Go From Here?
There is a lot to consider when refinancing a primary home to purchase a second home. Your primary home was used for collateral to purchase your second home. This means if you fall behind on your mortgage payments on the second home, you risk losing your primary home.
Juggling two mortgages is not easy, and most homeowners are required to live in the primary home for at least a year. The best advice is to first shop around and not just stay with your current mortgage company. Then, you can decide which financing option works best for you.
If you spend a little time doing research upfront, you could save thousands of dollars down the road. To get started with comparing rates on mortgages, click the button below. Once you enter your zip code, you’ll be directed to SuperOffers, where you can compare mortgage rates from providers in your area.