Put your second home equity to work
According to CoreLogic, the average homeowner gained more than $26,000 in home equity in 2020.
If you own a second home or vacation home in a sought-after area, you may have seen even bigger equity gains than average.
But what happens if you want to tap that equity? Can you take out a home equity loan or HELOC on your second home?
The answer may be yes, but the rules are a little different than for your primary home. Here’s what to expect.
In this article (Skip to...)
- Home equity loans on second homes
- Rules and requirements
- Home equity loan vs. cash-out refi
- Why are second home loans different?
- Interest rates
Home equity loans and HELOCs on second homes
You don’t have to sell your vacation home to access the equity it’s built up.
Instead, you could access the value of your home using a cash-out refinance, home equity loan, or home equity line of credit (HELOC).
Cashing out on a second home can be more appealing to some homeowners than changing the mortgage on their primary home or reducing its equity.
Using your second home reduces the risk of being in a negative equity position with your primary residence should the market take a turn for the worse.
Fortunately, many lenders and banks are offering home equity loans on second homes.
It’s a little more complicated if you’re trying to refinance a property that isn’t your primary residence, but that doesn’t mean you can’t benefit from historically low interest rates if you do your homework.
Rules for a second home HELOC or home equity loan
Due to the elevated risk that second homes pose for lenders, second home financing typically comes with higher interest rates and stricter financing rules.
Buying a second home involves a higher down payment of 10 percent or more. And if you’re refinancing a second home you already own, you’ll need enough equity to make cashing out worth it.
You often need to leave at least 25% of your second home equity untouched, which means you’ll need significantly more than 25% equity to make a cash-out refinance or home equity loan worth your while.
Additionally, credit score requirements are higher on second homes, and debt-to-income ratio guidelines are stricter.
Additional qualifications may include:
- Owning the property for at least one year
- Higher credit scores (often 680-700+)
- Bigger down payments, resulting in lower loan-to-value ratios (LTVs)
- Restrictions on geographic location
The good news is, second home mortgage rules are more lenient than those for investment properties. So it will be easier to find lenders offering home equity loans and HELOCs on your vacation home than on an investment or rental property.
Home equity loan versus cash-out refinance
Fortunately, even though there are stricter requirements, you won’t be forced into just one loan option in order to access the equity in your second home.
From a home equity loan to a home equity line of credit or a cash-out refinance — you have alternatives.
Whether or not you should do a cash-out refinance or opt for a home equity loan will depend on your specific situation.
Home equity loan or HELOC
If you already have a low fixed rate on your existing loan, a home equity loan is definitely worth looking into. This way you can preserve the low rate and payment on your existing mortgage.
Plus, with a home equity loan or HELOC, you won’t have to start the loan term over and extend the total amount of time you’re paying interest. This can make a second mortgage more appealing to someone who’s nearly done paying off their existing mortgage balance.
Deciding between a home equity loan or HELOC can be complex, so you’ll want to do your research. But here are the basics:
- Home equity loans involve taking a lump sum from your home equity, which you typically pay back over a set repayment period at a fixed interest rate
- Home equity lines of credit involve taking out a revolving line of credit, secured by your home’s equity, which you can borrow from and repay as often as you want within a set ‘draw period.’ After the draw period ends, you’ll have a set amount of time to pay back the outstanding balance. HELOCs typically have variable rates
Both these options are second mortgages — meaning you’re taking out a new loan on top of your existing mortgage loan. You’d then have two monthly payments, likely to two different lenders
If you have an above-market rate on your current mortgage, cash-out refinancing could help you withdraw equity and reduce your interest costs at the same time.
Because a cash-out refinance is a ‘first’ or ‘primary’ mortgage, it will typically have a lower interest rate than a home equity loan or line of credit, both of which are second mortgages.
Just note, the rules for a cash-out refinance on a second home will be more stringent than cashing out a primary residence.
Expect to have higher interest rates, increased equity requirements, and higher minimum credit scores. In addition, closing costs are typically higher for cash-out refinancing than for a second mortgage.
Why are the rules different for second homes?
Prior to the housing downturn of 2008, homeowners could easily tap into their home’s equity — and with very little equity at that.
But after 2010, mortgage lenders began to pull back on those loose guidelines.
Instead of loaning up to 100% of your home’s equity with relatively few credit requirements, many lenders stopped offering home equity loans of any type on second homes.
Why? Unlike your primary residence, home loans for vacation properties are higher risk for lenders.
Your primary residence is considered to have the least risk when it comes to real estate. The home where you live is most likely the one debt that gets paid, regardless of tough times.
Vacation homes, on the other hand, are riskier. If times get tough, homeowners are more likely to forego those mortgage payments when money is short.
On top of that, second mortgages — including HELOCs and home equity loans — are already considered higher risk. That’s because these loans fall into ‘second lien’ position (behind your first mortgage), meaning they could get paid less or not at all in the event of a foreclosure.
So, with the dual risk factors of a second mortgage on a second home, lenders are naturally more reserved about offering these loans — and they charge higher interest rates when they do.
Don’t forget to shop around for interest rates
Buying a vacation home means you can enjoy the financial benefits of owning real estate, as well as having a great place to vacation with your family.
Mortgage borrowers will find different lending standards for different types of property, depending on the lender and the mortgage program. If you can’t find a lender that can help you, try a smaller, local bank or credit union.
Remember to always shop and compare loan options for your specific needs and financial goals.